National Institute of Business Management

1. Describe the basic assumptions of Economics.
2. Discuss the vital functions of an economy.
3. Write an essay on the features of capitalist economy.
4. Explain the various assumptions on which all demand schedules are prepared.
5. Write an essay on Localization of Industries.
6. Describe the kinds of price elasticity of demand.

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25 x 4=100 marks

Answer of Question 1-
Basic assumption of econimoics
Economists have generally looked for some fundamental assumption about human behaviour from which most of the principles of economics can be ultimately deduced. Every decision maker in an economic systems-wheter he is a consument or producer, whethre is a house hold or a firm is assumed to have in a rational manner and go in for maximum gain. Economic rationality presupposed that every person knows his interest and selects that course of action, which promises him the greatest amount of statisfaction.

The economists have, generally assumed that human beings are rational and that they are influenced by maximization principle for example every consumer is said to maximize his satisfaction with a given amount of expenditure, every producer maximizes his output and mizimizes his cost. Every seller minimizes his profit, as so on.

But reationality and maximization principles are based on the further assumption of perfect knowledge, every rational consumenr for example knows the differnent possiable alternative open to him and will choose that alrernative that promises maximum satisfaction. However, rationality is conditioned and influenced by habits and social. Habits acquired over a number of years influence the consumers in the choice of goods. Likewise, social customs infulence guide and modify economic behaviour of individuals.

The assumption of economic rationality does not carry and moral or ethical implication. Rationality implies that is a period of acute shoratege, producers and distributors would raise the price and secure higher profit marigns. Such a behaivor may be condemned from the social point of view. But economically it is justified. At the same time, it is neccesasary to distinguish between individual rationality and social rationlaity. But from the social point of view, this may not be rational and proper, for bombay is already overcroweded with a high density of population, besides there are so many backward areas, which need industrialization from the social point of view it would have been better that the new factory is set up away from bombay, there is thus a possibility of clash between individual rationally and social rationalily.

Anwer of Question no :- 2

An economy refers to the financial system of the region, province or nation. “It is a system by which folks get a livelihood.” For instance the “Economy includes farms, factories, mines, shops, banks, roads, railways, aircrafts, offices, schools, cinemas etc., which grants the people with the goods and services which they also use themselves or sell overseas in order to be able to buy imports.” Sir John Hicks “An economy consists of nothing else but an enormous cooperation of workers or manufacturer to make things and do things which clients want.”

The Vital Processes of An Economy

Production, consumption and growth are vital factors of economics. Economies might differ in the organisation but all perform these three functions which are discussed below.

1. Production -The First vital process of an economy is manufacture which must go on incessantly. “Production comprises any action, and the stipulation of any service, which satisfies and is likely to satisfy a want.” In this wider sense, production includes products produced on farms like rice, wheat, fruits and vegetables and those manufactured in the factories like clothes, electronic goods, electrical items etc. It also includes the services of shopkeepers, traders, transporters, actors, doctors, civil servants, teachers, engineers and akin to who help in fulfilling the needs of the people in the economy through their services. But production eliminates certain goods and services though they satisfy human needs. It includes, domestic work done within the family by the housewives, husband and children, production of hobby articles like paintings, production of vegetables in the kitchen garden. The last is voluntary work. John Hicks defines “Production is any activity directed to satisfaction of other people’s wants through exchange.” Thus production means exchange of goods for consideration of money.

2. Consumption -The second vital process of economy is consumption. It means the use of financial goods and services in the pleasure of human needs. The consumption that goes on in the fiscal may be of different types. Prof. Hicks organized it into two grouping – single-use goods and durable-use goods. Single goods are those which are used in a single act. Such goods are food stuffs, cigarettes, matches, fuel etc. durable use goods are those which can be used for a substantial period of time. It is unimportant whether the time is short or long. Such goods are pens, bicycles, clothes, fans, furniture etc. Prof. Brown defines as “For every kind of completed goods, in reality there is a kind of channel or rather a system of pipeline, elongating from the unique sources of resources used to the consumer.” The accretion of stock of such goods is called inventory investment.

3. Growth -Economic growth is “the process whereby the real per capita income of a country increases over a long period of time.” We itemise the factors which lead to the growth of an economy.” Growth of population predominantly working population is the first cause of growth. A rapidly growing population in relation to the growth of the national product keeps the output per head at a low level. On the other hand, the enhancement in the productivity per head of developed economies like United States has been much higher because of their low rates of their national product.

Technical acquaintance and development are the twin features in mounting productivity per head. Technical knowledge and development are autonomous It is technical knowledge which brings about new means of production, leads to innovation and growth of new equipment. The supply of savings is another factor that determines the growth rate of economy. Borrowing from abroad is another source of capital for the growth of economies. External borrowing is resorted to for two reasons. To supplement low domestic savings and to get foreign currency for the purpose of importing capital for development purposes. Thus all economies whether they are capitalist, socialist or mixed perform these important functions of production, consumption and growth. Central Problems of Economy

There are five fundamental questions relating to the problem of economy and they are discussed below.

1. What to Produce and in What Quantities?
To make a decision of what goods and services are to be created and the volume of productivity has to be determined and this is the first problem relating to economy. This involves allotment of scarce resources in relation to the composition of total productivity in the economy. Since resources are inadequate the society has to decide about the goods to be produced. If the society gives significance to the production of more consumption goods now, it will have less in future. A high precedence on capital goods implies consumer goods now and more in future. But since resources are inadequate, if some goods are produced in abundance, some other goods will have to be produced in smaller quantities. It will therefore have to choose among mixture which will give higher level of satisfaction.

2. How to Produce these goods?
The next problem is how to fabricate these goods. That is the techniques and methods to be applied in the production of the necessary goods. This problem is principally dependent on the accessibility of resources within the economy. If land is available in abundance, it may have widespread cultivation. If the labour is in abundance, it may use labour demanding techniques while in case of labour shortage, capital intensive techniques may be used. On the other hand easy consumer goods and small outputs necessitate small and less costly machines. Further it has to make a decision of what goods and services are to be created in the public sector and that in private sector.

3. For Whom are the Goods Produced?
The third basic problem is for whom the goods and services are to be produced. That is the allotment of goods among the members of the society. The allotment of basic customer goods or supplies and lavish comforts and among the household takes place on the basis of among the allocation of country’s income. A rich person may have a large share of the lavish goods and a poor person may have more amounts of the basic consumer goods he needs.

4. How efficiently are the resources being utilised?
This is one of the significant basic problems because of having made the three earlier decisions, the society has to see whether the capital it owns are being utilised fully or not. In case the resources of the financial system are lying idle. It has to find out ways and means to use them fully. If the idleness of resources, say man power, land or capital is due to their male allocation, the society has to adopt such monetary, fiscal or physical measures where this is corrected. In an economy where the available resources are being fully utilised, it is characterised by technical competence or full employment. To maintain it at this level, the economy must always be increasing the productivity of some goods and services by giving up something of others.

5. Is the Economy Growing?

The last and the most imperative problem is to find out whether the economy is growing through time or is it sluggish. Economic growth takes place through a superior rate of capital configuration which consists of restoring existing capital goods with new and more productive ones by adopting more well-organized production techniques or through modernization. Economic growth enables the economy to have more of both the goods.

Answer of Question no: – 5
Manufacturing is the second largest type of production after primary production activity ‘of hunting, fishing, mining, lumbering, farming etc. Manufacturing has undergone a big change as a result of advancement of science and technology. From the making of few simple items, like hand made cloth, khandsari, mustard oil, agricultural implements etc. manufacturing to-day involves highly technical and complex machines, equipments and tools for the assembly of automobiles, ships, aircrafts, space ships, agricultural machines, computers and so on. For centuries, manufacturing had been a household work and items like agricultural implements; weapons etc. were produced on a small-scale. But with the increasing demand due to increase in population, it took the form of cottage industry and later, large scale manufacturing industries.

Manufacturing is related to processing and altering the raw materials of agriculture, forests and that of minerals into finished or partially finished products. The agro raw materials which are transformed into finished products are cotton, wool, jute, sugarcane etc. and that of minerals are iron ore, copper, manganese, mica etc. Presently, the most important manufacturing industries are those which bring together manufactured items of different industries to make complicated machines and equipments required in means of transportation, agriculture, mining, military warfare etc. Development of industries is of utmost importance to man. In fact, their development is considered to be an index of a country’s economic prosperity and strength. The location of manufacturing industries depends upon a number of geographical and economic factors. These factors are known as factors of localization of industries or agglomeration of industries. The most important factors are:

(i) Raw material.
(ii) Source of Power.
(iii) Labour.
(iv) Means of transportation.
(v) Market.
(vi) Other factors like climate, Government Policies, capital, water, land etc. (i) Raw Material.
Among the factors influencing location of an industry, close proximity to raw material availability of regular supply of cheap raw material are of utmost significance. Therefore, industries are set up close to or in the regions where raw material is available in plenty. This speaks for the localization of jute industry in West Bengal, Sugar industry in U.P and concentration of heavy industries in the states of Chattisgarh and West Bengal. If the raw material is heavy and of small value, the industries are set up in the regions of raw material. Iron smelting, brick making, cement manufacturing are best examples. Iron and Steel Plants at Jamshedpur (Jharkhand), Rourkela (Orissa), Bhilai (Chhattisgarh) and Durgapur (West Bengal) have been set up near the sources of raw material i.e., Iron ore. (ii) Source of Power.

All types of manufacturing industries depend upon one or the other sources of power. It may be coal, oil, electricity, gas etc. In the industries, especially those of ferrous metallurgy, coal is the main source of power; therefore, these heavy industries are closely tied down to coal fields. The iron and steel industry of India in the Damodar Valley of Chattisgarh at Jamshedpur is located near the coal fields of Raniganj and Jharia. (iii) Labour.

Modern industry requires large labour force, both skilled and unskilled. The availability of cheap labour in a region is an important factor determining the localization of industries. Different types of industries require different types of labour force. For example, watch-making, electronics, aeronautics, computers etc. require highly skilled labour, whereas, on the other hand, cotton textile manufacturing, sugar making, jute textile etc. employ more of unskilled labour. The development of the plantations in Assam and cotton textiles in Maharashtra are attributed to the availability of cheap efficient labour. In these regions it has also been seen that industrial centres tend to attract more industries, because plenty of labour is available in these centres, for example, Mumbai and Kolkata have become industrial cities of the country mainly because of availability of plenty of labour in and around these mega cities. (iv) Means of Transportation.

Industries depend upon efficient and cheap transportation system, which is essential for the movement of raw material as well as the finished products. They may be rail, road or water. Railway junctions are considered to be the most suitable sites for the localization of industries. These enjoy benefits of easy transportation from different directions. Similarly sea ports also develop as industrial centres because of availability of facilities of water transportation for export and import of products. (v) Market.

Market is an important factor in determining localization of industries. Goods are manufactured to be sold in the market. Industries are generally set up close to urban centres. Sometimes, dense population may not prove to be solid market for the disposal of the different industrial products. If the people are poor, the purchasing capacity also becomes poor. In some of the Asian countries, where people are poor, industries which are engaged in the manufacturing of cheap and essential goods like coarse cloth find an adequate market. This explains why under-developed countries, though densely populated are poor in manufacturing industries. (vi) Other Factors.

(a) Climate
Climate also plays a part in the location of industries. The stimulating cool temperate climate is more suitable for the development of industries because this type of climate adds to the work efficiency of the labour force. This is one of the major reasons why temperate latitudes have well-developed manufacturing industries rather than the tropics or the desert or the Tundra regions. Climate plays a significant role in location of cotton textile manufacturing industries. The cool and humid climate helps in spinning of yarn and weaving of cloth processes. Development of film industry at Mumbai is due to favourable climate. (b)Capital.

Development of industries requires a large capital investment. It may come from any source, local or foreign. Banks and other financial institutions play an important role in the growth of industries from time to time. (b) Government Policy.

In order to give boost to industries in the country, the government gives certain guidelines, tax exemptions, electricity at concessional rates, subsidies, rail link etc., if these are set up as per government plan. Mohali, an industrial town near Chandigarh has come up on the industrial map of India because of Government policies. Thus Government Policy plays a significant role in determining place of location of an industry. If the Government bans import of foreign cars, the automobile industry is bound to flourish in that country. (d)Early Start.

There is a tendency to set up new units in the area, where that industry is already much developed. It is because the area has been enjoying benefits of developed means of transport, financial institutions, banking facilities, availability of skilled labour and marketing ease. Hosiery industry got concentrated at Ludhiana can be cited as one example of role of early start. (e) Personal Preferences.

Personal whims, prejudices of an entrepreneur and preferences also matter sometimes in the setting up of an industry in an area, ignoring all the economic and commercial considerations. In a democratic set up, sometimes political matters also initiate the establishment of certain heavy industries in certain regions. The setting of a Railway Coach Factory at Kapurthala in Punjab has been set up due to political interests rather than economic considerations. Construction of oil refinery at Bhatinda is another example of a political decision. Localization of industries at a place gives rise to a number of problems also. These are:

(i) High cost of living.
(ii) Shortage of living space.
(iii) Sky high land prices.
(iv) Traffic jams.
(v) Pollution.
(vi) Growth of slums.
Some of the industries are highly localized in the country. These are due to combination of a number of geographical and socio-economic factors already discussed above. The examples are:

1. Sugar Manufacturing: U.P. and Bihar.
2. Jute Textiles: West Bengal.
3. Cotton Textiles: Maharashtra and Gujarat.
4. Cement Industry : M.P. and Rajasthan.
5. Iron and Steel: Jharkhand and Orissa.
6. Cinematography Mumbai
7. Leather goods: Kanpur, Agra.
8. Hosiery: Ludhiana.
9. Sports goods: Jalandhar.
10. Computers: Bangalore, Hyderabad, Gurgao

Answer of Question no :- 6
Different types of Elasticity of Demand
After knowing what is demand and what is law of demand, we can now come to elasticity of demand. Law of demand will tell you the direction i.e. it tells you which way the demand goes when the price changes. But the elasticity of demand tells you how much the demand will change with the change in price to demand to the change in any factor. Different types of Elasticity of Demand:

1. Price Elasticity of Demand
2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Advertisement Elasticity of Demand
1. Price Elasticity of Demand:
We will discuss how sensitive the change in demand is to the change in price. The measurement of this sensitivity in terms of percentage is called price Elasticity of Demand. According to Marshall, Price Elasticity of Demand is the degree of responsiveness of demand to the change in price of that commodity. Types of Price Elasticity of Demands:

a) Perfectly Elastic
b) Perfectly Inelastic
c) Relatively Elastic
d) Relatively Inelastic
e) Unit Elasticity
Factors influencing Price Elasticity of Demand:
a) Nature of Commodity
b) Availability of Substitutes
c) Number of Uses
d) Durability of commodity
e) Consumer’s income
Practical significance of Price Elasticity of Demand:
a) Importance to the business
b) Important to Government
2. Income elasticity of demand:
In economics, the income elasticity of demand measures the responsiveness of the quantity demanded of a good to the change in the income of the people demanding the good. It is calculated as the ratio of the percent change in quantity demanded to the percent change in income. For example, if, in response to a 10% increase in income, the quantity of a good demanded increased by 20%, the income elasticity of demand would be 20%/10% = 2. 3. Cross elasticity of demand:

In economics, the cross elasticity of demand and cross price elasticity of demand measures the responsiveness of the quantity demand of a good to a change in the price of another good. It is measured as the percentage change in quantity demanded for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the quantity of new cars that are fuel inefficient demanded decreased by 20%, the cross elasticity of demand would be -20%/10% = -2. 4. Advertisement Elasticity of Demand:

The degree of responsiveness of quantity demanded to the change in the advertisement expense of expenditure. Ea= Change in quantity demanded x original advertisement expenses Change in advertisement expenses original quantity demanded

Important factors influencing Advertisement:
1. Promotional elasticity of demand will be affected, depending on whether it is a new product or the product with a growing market.
2. The amount a competitor reacts to the firm’s advertisement.
3. The time interval between the advertisement expensed or expenditure and the unresponsiveness of the sales.
4. The influence of non-advertisement determinants of demands such as trends, price, income etc. Uses of Advertisement Elasticity of Demands:

1. It helps the manager to decide the advertisement expense. If the advertisement is more than one, which means incremental revenue exceeds incremental expenses, then increased expenditure on advertisement can be justified.
2. The fire should observe the saturation point, where advertisement pays nothing or does not help in increasing sales revenue

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