CBSE TUTORIALS

 

STUDY MATERIAL-ECONOMICS (XII)
CBSE Syllabus

How to use this Study Material?

        This study material contains gist of the topics / units along with the assignments for self  assessment. Here are some tips to use this study material while revision during pre-boards and finally in board examination.

*      Go through the syllabus given in the beginning. Identify the units carrying more weightage

*    Suggestive blue print and design of question paper is a guideline for you to have clear        picture about the form of question paper.

*      Revise each of the topics / units and attempt the questions given for self assessment.

*   After attempting the self assessment part, consult the question bank where questions carrying one, three/ four, six marks are given. Revise them

*     After revision of all the units, solve the sample paper, and do self assessment with the value points.

*  Must study the marking scheme/solution for CBSE economics previous year paper which will enable  you to know the coverage of content under different questions.

*  Underline or highlight key ideas to have birds eye view of all the units at the time of examination.

*      Write down your own notes and make summaries with the help of this study material.

*      Turn the theoretical information into outline mind maps.

*      Make a separate revision note book for diagrams and numerical as well

*      Discuss your ‘DOUBTS’ with your teacher / other students.

Important:-

a) Slow learners may revise the knowledge part first.

b) Bright students may emphasize the application part of the question paper.                    

UNIT - I

INTRODUCTION

According to A.G Brown, an economy  is a system by which people get a living,  “An economy is a system that provides people with the means to work and earn a living in the process of production,  “All such institutions and organizations, which provide people with the means to work and earn an income, are collectively called an Economy.

Basic activities of an Economy.

1.         Production refers to creation of utility or increasing the value of commodities already        produced.

2.         Consumption is using up of goods and services to satisfy human want directly.

3.         Capital Formation/Investment refers to addition to the capital stock of an economy.

Economic Problem :- It is basically problem of making choices in the use of scarce resources  for satisfaction of choice arises due to scarcity of resources and their alternative uses, For an economy Economic problem is the problem of resource allocation or making choices in the allocation of scarce resources having alternative uses.

Causes of Economic Problem:

(i) Human wants are unlimited  (ii) resources to satisfy wants are limited (iii) resources have alternative uses.

Central (Basic) Problem of an Economy Allocation of resources or making choices among alternative uses of scarce resources is the fundamental problem.

1.         What to produce and in  what quantity?

            It is the problem of choosing which commodities should be produced and in what quantity i.e. necessity goods or luxury goods.

2.         How to produce?

            It is problem of choosing method or technique of production of goods. i.e. Labor intensive or Capital intensive.

3.         For whom to produce.

It refers to distribution of  factor income  among various factors of production since production is the result of combined efforts of factors of production i. e. Iand, labor, capital, enterprise.

DISTINCTION BETWEEN MARKET ECONOMY AND CENTRALLY PLANNED ECONOMY.

1-         Market Economy : An economy in which all economic activities are organized through the market i.e. free interaction of buyers and sellers to affect purchase and sale of a commodity.  (Price mechanism)

Central Problems of what, how and for whom to produce are solved by price-mechanism.

2.         Centrally Planned Economy :- It is one in which all important activities  are planned and decided by the central planning authority or the Govt.

Central Problems of what, how and for whom to produce are solved by the central authority known as planning commission appointed by the Govt.

Branch of Economics

1.         Micro economic theory (also called Price Theory) deals with the allocation of resources which is decided by price mechanism.

2.         Macro-economic Theory deals with full employment of resources along with other aggregates of economy i.e. national income, price level, national saving etc.

Production Possibility Frontier

It is a curve which depicts all possible combinations of two goods which an economy can produce with available technology and with full and efficient use of its given resources.

Assumption

1.         Resources are fixed.

2.         Resources are  fully & efficiently used.

3.         Technology does not change.

4.         Resources are not equally efficient in production of all goods.

Production Possibility Schedule

with MOC & MRT

Production  Possibilities	Wheat (w) (Lakh tonnes)	TanKs(T) (thousands)	MOC of Wheat	MRT= ∆ tanks/ ∆wheat
A	O	15	-	-
B	1	14	1(15-14)	1 W = 1 T
C	2	12	2(14-12)	1 W = 2 T
D	3	9	3	1 W = 3 T
E	4	5	4	1 W = 4 T
F	5	0	5	1 W = 5 T

By joining the different possibilities of production i.e. wheat on x-axis and tanks on y-axis production possibility curve is drawn.

  

Every point on PP curve (A, B, C, D, E) reflects situation of full and efficient employment resources.

2.         Point Below PP curve reflects the selection of inefficient utilization or under-utilization of     resources. (Leftward shift)

3.         Point above PP curve indicates situation of growth of resources. (Rightward shift)

SHAPE OF PRODUCTION POSSIBILITY CURVE

1.         It slopes down from left to right because in a situation of full employment of resources production of one good can be increased only after sacrificing some quantity of other good.

            (1 W = 2 T............ ..............)

2.         The shape of PP curve is concave to the origin due to increasing marginal opportunity cost. It implies that for producing an additional unit of a good, sacrifice of units of other good goes on increasing.

(*)        PP curve could be a straight line if sacrifice of units of good is constant. MOC (MRT) is constant.

OPPORTUNITY COST :-  It is equal to the value of next best alternative forgone (sacrificed)

Marginal opportunity cost :- It refers to the amount of other good which is sacrificed to produce an additional unit of the particular good.

Marginal Rate of Transformation : It is defined as the ratio of units of one good sacrificed for production of an additional unit of other good.

Positive economic analysis :-

1.         It studies the actuals as “they are”

2.         It analyses the cause & effect relationship.

3.         Ethics of  economic decisions are not touched. i.e. INDIA is over-populated.

Normative economic analysis :

1.         It deals with things as they ought to be”

2.         It passes moral judgement.

3.         It deals with idealistic situation instead of actual situation i. e. Interest free loans should be given to the poor farmers.

Micro economics :- It is that part of economic theory which deals with the individual parts of the economic system such as individual households, individual firms or industries.

It is called price theory because it is concerned with the determination of price of individual commodities and factors.

Macro economics: - It is that part of economic theory which studies the economy in its totality or as a whole, dealing with aggregates. such as ‘National income, aggregate employment, general price-level

It is also known as “Theory of income and employment because the subject-matter of macro-economics revolves around determination of the level of income & employment.

1 mark questions OR 3/4 marks question.

1.         Why is PPC downward sloping from left to right?

2.         What does increasing MOC along a PPC mean?

3.         Which factors lead to a shift of the PPC?

4.         What does a rightward shift of PPcurve indicate?

5.         What is economics all about?

6.         “Massive unemployment shifts the PPC to the left. Defend or refute.

7.         A lot of people die and many factories are destroyed because of severe earthquake in the country. How will it affect country’s PPC

8.         Give two examples of under-utilisation of resources.

9.         Give two examples of growth of Resources.

10.       Why does technological advance or growth of resources shift the PPC to the right.

HOTS

Qes1.  How is a   market economy different from a centrally planned economy.

Qes2.  How are central problems solved in market and centrally planned economy.

Qes3.  From the following PP schedules, calculate MRT of good X.

Production Possibilities                       A          B          C         D         E

Production of good X (units)               0          1          2          3          4

Production of good y (units)               14        13        11        8          3

Qes4.  Why is PP curve concave to the origin.

Qes5.  Does production take place on a PP curve? Explain.

Qes6.  Can a PP curve be a straight line?

Qes7.  Why do Central problems arise? Explain.

Qes8.  Calculate marginal opportunity cost of cloth in terms of sugar at different production possibilities from the data.

Production Possibilities                       A          B          C         D         E          F

Cloth (million mt)                                 0          1          2          3          4          5

Sugar (million kg)                                50        45        40        35        25        20

UNIT - II

                                            CONSUMER EQUILIBRIUM & DEMAND                                   

Utility:- It is the want satisfying power of a commodity. This is measured in terms of ‘utils’.

Utility can be of two types.

(a)        Total Utility:- TU is the sum total of satisfaction  that the consumer derives when a certain number of units of a particular commodity are consumed. 

             Tux= f(Qx) or TU = ∑ MU

(b)        Marginal Utility:- MU is the additional satisfaction derived from the consumption of an additional unit of the commodity.

                                                    MUn = TUn – TUn-1

 

Alternatively;                                MUx= ∆ TUx/ ∆/Qx

Law of diminishing marginal utility (DMU):- As a consumer goes on consuming more and more units of a commodity the additional benefit that he derives from the additional unit of a commodity goes on falling.

This law is based on following assumptions:-

1.         Standard unit of measurement is used.

2.         Homogeneous commodity.

3.         Continuous consumption.

4.         Mental and Social condition of the consumer must be normal.

5.         No change in income, tastes, fashion and price.

Utility schedule and utility curve:- The law of DMU is numerically illusrated in terms of utility schedule. It shows the TU & MU derived by a consumer as he consumes more and more of good X.

Utility function:-

           

 Quantity of Good X                 TUx           MUx = (∆ TUx/ ∆/Qx)

            1                                     18                    18

            2                                     34                    16

            3                                     46                    12

            4                                     51                    05

            5                                     51                    0

            6                                      43                    –8

Relationship between TU and MU

•          When MU diminishes TU increases as shown in the diagram point A to C and B to D.

•          When MU is zero TU is maximum (point C & D)

•          When MU is negative TU declines (point E & T)

Consumer’s Equilibrium:- The main aim of the rational consumer is to maximise satisfaction with the given resources (budget constraint) and he does not want to bring any change in it. Suppose a consumer wants to buy a commodity. How much of it should he buy?

Two approaches are used for getting an answer to this question.

1.         Consumer’s Equilibrium with Utility approach:- Cardinal measurement of utility where utility of different units of a good not be added or subtracted.  

2.         Consumer’s Equilibrium with Indifference curve approach:- Ordinal measurement of utility where the utility can be compared or ranked. In this theory, utility of different units can not be added or subtracted.

I. Utility approach:- Marshall explained it with cardinal measurement of utility.

Assumptions of Utility approach:-

 

1.         Consumer is rational i.e. Maximum Satisfaction out of his limited income.

2.         Utility can be measured in cardinal numbers.

3.         Marginal utility of money is constant.

4.    Utility of each commodity is independent of the prices and utilities of other commodities.

5.         No change in the taste and prices of the commodities and income of the consumer.

Consumer’s Equilibrium — Single commodity case:-

It is attained when marginal utility of commodity in terms of money becomes equal to its price.  MUx = Px

Since it is difficult to compare MU of a good (expressed in utils) with its price (expressed in Rs) therefore MU of a good is first converted in terms of money by dividing MU of a good with MU of a rupee. 

                        (MU of good/MU of a rupee) = Price of the commodity       

                        The above condition can be explained with utility schedule.

                      
   Units of X        Price of X (Px)      MUx

     1                      5                           8        Mu > p

     2                      5                           6

     3                      5                           5        Mu = p

     4                      5                           4        Mu < p

      5                        5                               3

MUx = Px (MUm) ® Point E

MU>P             ®        Point C

MU<P             ®        Point D

Consumer Equilibrium in case of two commodities

When a consumer wants to buy two commodities his equilibruim will be determined in accordance with the law of equi-marginal utility. He will distribute his money income among these goods in such a way as he gets equal marginal utility in terms of money from all the goods. In case of two goods consumer equilibrium would be:

                                               

            It can be explained with the help of following table and a diagram.

            Unit of Money MUx - good (units)                  MUy - good (units)

            1                                  14        (1)                                10        (3)

            2                                  12        (2)                                8          (5)

            3                                  10        (4)                                6

            4                                  8          (6)                                4

            5                                  6                                              2

            6                                  4                                              0

                                               

In this case when consumer spends 4 units of money on x-good and 2 units of money on y-good, he gets equal marginal utility of 8 units. When Marginal utilities are equalised TU is maximised. Here, TU = 14+12+10+8+10+8 = 62 units. In no other case, consumer can get utility of 62 units or more than.

Utility is maximum when

 At point T where,

It shows that OT is spent on good x and O, T on good y. Accordingly the consumer is at point R on the MUx curve and at point S on MUy curve. There is a loss of utility shown by the shaded area.

This prompts the consumer to transfer some of expenditure from y to x till he reaches to point ‘E’

Consumer Equilibrium with Indifference Curve Approach

J.R. Hicks has explained consumer’s behaviour on the basis of ordinal utility theory known as I.C. Approach.

I. C. is a locus of all such points, each of which represents a combination of two goods and yield equal satisfaction to the consumer on all the points.

Assumptions of I.C. Analysis

1.         Rationality:-     He would like to get maximum satisfaction with given income and price.

2.         Ordinality:-      He can rank his preferences on the basis of satisfaction of each basket of goods.

3.         Diminishing marginal rate of substitution:-      The rate of substitution of one commodity for another is known as MRS = ∆y/∆x. It has always declining trend because law of diminishing marginal rate of substitution applies upon consumer while making different combinations.

4.         There is consistency in consumer’s behaviour.

5.         There is no change in the taste and preferences of consumer.

6.         Prices of goods and income of the consumer are given.

7.         Monotonic preferences :-       A consumer’s preferences are monotonic if and only if between any two bundles the consumer prefers the bundle which has more of at least one of the goods and no less of the other good as compared to the other bundle. eg point M which is above I.C.

Indifference Map:- It refers to a family of indifference curves which gives a complete picture of a consumer’s scale of preferences for two goods. Moving away from the origin moves the consumer to higher levels of utility.

Properties or Feature of I.C.

1.         Downward sloping to the Right:- It is based on the assumption that both the goods give the consumer positive satisfaction. This assumption is called monotonicity of preferences.

2.         Convex to origin:- A downward sloping curve can be a straight line, concave or convex to the origin. The difference is that of slope. Which measures the substitution ratio between the two goods.
Slope of I.C. =∆y/∆x  = MRSxy

 Slope of I.C =  ∆y/∆x= MRSxy

 

Diminishing MRS:-

It means as the consumer has more and more of x, its subjective worth or marginal significance to him declines and that of scarce commodity Y goes up. He is willing to give up less & less of Y for an increment in X. It implies indifference curve is convex to the origin.

3.         Two curves do not intersect each other:- If they intersect then we get contradictory results in terms of preference ranking. Point A & B lie on the I.C1.
 The consumer must be indifferent between them. 
Consumer must be indifferent between points B & C lying on IC2. By the assumption of transitivity consumer must be indifferent between point A & C. Comparing these two points C is better as it has more units of good 


Y. Contradictory results appear.

4.         Higher the Indifference curve, higher is the level of satisfaction:- On higher IC we get more goods without reducing another, therefore higher the IC higher is the level of satisfaction.

In the side diagram in IC2 the consumer will derive more satisfaction as it has more units good X and same amount of good Y in comparison to IC1.

Budget Set & Budget line

Budget Set:- It is a set of bundles of goods available to the consumer at a given price and income.

Budget line:- It is the graphic presentation of all combinations that consumer can buy with his entire income at prevailing prices.

Budget constraint:- It shows that a consumer can choose any bundle as long as it costs less or equal to income and prices of goods.

Changes in the Budget line:- The set of available bundles depends on (1) the prices of the two goods and (2) the income of the consumer.

1.         When there is change in price of a single good budget line rotates to the left or right. 
When price of good x falls, Budget line rotates to the right. 

When price of good x rises the line rotates to the left.

Suppose consumer income changes but the prices of the two goods remain unchanged. With new income consumer can afford to buy all bundles (x1 ; x2) such that .The slope of the new budget line is the same as the slope of prior budget line. If income of the consumer increases the budget line shifts rightward and if the income of the consumer falls the budget line shifts leftward. So the vertical intercept has changed after the change in income.

Optional choice of the consumer:- A consumer shall be in equilibrium where he can maximize his satisfaction subject to his budget constraint. Thus it refers to a situation in which a consumer with his given income and given prices purchases such a combination of goods which gives him maximum satisfaction and he does not want to bring any change in it.

Conditions of Consumer’s Equilibrium:

1.         Budget line should be tangent to I.C. i.e.

At this level of slope of IC and budget line are equal to each other.

 
2. Indifference Curve should be convex to the point of origin at the equilibrium point.

The point where two conditions are fulfilled represents consumer’s equilibrium. ‘R’ is the equilibrium point. Any other point can not be considered an optimum point because they lie on lower IC and any point lying on IC3 is beyond the reach of the consumer.

Demand:-        “It refers to the quantities of a commodity that the consumers are able and willing to buy at a each possible price during a given period of time, other things being equal”.

Demand function:- It is a technical term which shows the functional relationship between demand for a commodity and various determinants of demand.

Factors Determining demand

1. Price of the commodity:- There is a negative relationship between quantity demanded and price.

2.   Income of the consumer:- The effect of income on quantity demanded depends upon the nature of goods.

(a)   Normal goods- There is a positive relationship between income of the consumer and demand for a good.

(b)    Inferior goods- There is a negative relationship between income of the consumer and a demand for a good