Solutions Of BECC-101 TEE Questions (June 2024)

These are detailed & structured answers to the questions from of the economics exam paper. Explanations are clear, with key concepts, reasoning, and where relevant, descriptions of graphs (as textual diagrams cannot be drawn here, but standard shapes are described).

Section—A1.

(a) What do the following signify?

(i) Movement from one point on the PP-curve to another.

This represents a reallocation of existing scarce resources between the production of two goods (or sets of goods), keeping total resources and technology constant. It shows a change in the combination of goods produced (e.g., more of one good and less of the other) while staying on the frontier. This illustrates the concept of opportunity cost and trade-offs in a fully employed economy.

(ii) Movement from a point within the frontier to a point on the frontier.

This signifies an increase in resource utilization or efficiency without any change in resource quantity or technology. A point inside the Production Possibility (PP) curve (also called Production Possibility Frontier or PPF) indicates underutilization of resources (e.g., unemployment or inefficiency). Moving to the frontier means achieving full employment and/or better efficiency, increasing total output without shifting the curve.

(iii) An outward shift in PP-curve.

This indicates economic growth, an increase in the economy’s productive capacity. It occurs due to increases in the quantity/quality of resources (e.g., more labor, capital, better education) or technological progress/improvements. The economy can now produce more of both goods simultaneously.

(b) “Economics is a science of choice making.” Explain this statement.

Economics studies how individuals, firms, and societies make choices under conditions of scarcity. Resources (land, labor, capital, time) are limited, but wants/needs are unlimited, forcing choices about what to produce, how to produce, and for whom to produce. Every decision involves trade-offs and opportunity costs (the next-best alternative forgone). Economics analyzes rational choice-making to allocate scarce resources efficiently, maximizing satisfaction or output. Thus, it is fundamentally the science of choice-making under scarcity.

(c) Distinguish between the following:

(i) Static and Dynamic Economic analysis

Static analysis: Examines economic variables at a single point in time (snapshot), assuming “other things remain constant” (ceteris paribus). It ignores time, change, or adjustment processes (e.g., equilibrium price determination in a market at one moment).
Dynamic analysis: Considers changes over time, including sequences of adjustments, lags, expectations, and paths to new equilibria (e.g., how a market moves from one equilibrium to another after a shock, or economic growth over years).

(ii) Micro Economics and Macro Economics

Microeconomics: Studies individual economic units (households, firms, industries) and their decisions (e.g., consumer behavior, firm production, price determination in specific markets, resource allocation). Focus: individual parts of the economy.
Macroeconomics: Studies the economy as a whole (aggregates) — national income, employment, inflation, unemployment, growth, fiscal/monetary policy. Focus: overall performance, aggregates like GDP, general price level.

2. (a) Which causes shortage of a good – a price ceiling or a price floor? Justify your answer with a graph.

A price ceiling causes a shortage. A price ceiling is a maximum legal price set below the equilibrium price (e.g., rent control or price controls on essentials). At this lower price:

Quantity demanded increases (downward-sloping demand curve).
Quantity supplied decreases (upward-sloping supply curve).
→ Quantity demanded > Quantity supplied → shortage (excess demand).

A price floor (minimum price above equilibrium, e.g., minimum wage) causes surplus (excess supply), not shortage.Graph description (Demand-Supply):

Vertical axis: Price; Horizontal axis: Quantity.
Upward-sloping supply (S), downward-sloping demand (D) intersect at equilibrium (Pₑ, Qₑ).
Horizontal line below Pₑ at price ceiling (P_c).
At P_c: Q_d (higher on D) > Q_s (lower on S) → horizontal distance between Q_s and Q_d = shortage.

(b) What determines how the burden of a tax is divided between buyers and sellers? Why?

The tax incidence (division of tax burden) is determined by the relative price elasticities of demand and supply.

If demand is more inelastic than supply (buyers less responsive to price changes), buyers bear most of the burden (pay higher prices). Sellers pass on more of the tax.
If supply is more inelastic than demand, sellers bear most (receive lower net price).
If both equally elastic, burden shared roughly equally.

Why? The side with more inelastic curve cannot easily adjust quantity in response to price change caused by the tax, so it absorbs more of the price adjustment (burden). Elastic side reduces quantity more, shifting burden to the other side.3.

(a) “A typical production function has three stages.” Explain and illustrate graphically. In which stage of production does the firm typically operate?

A typical short-run production function (with one variable input, e.g., labor, and fixed inputs) has three stages based on marginal product (MP), average product (AP), and total product (TP):

Stage I: Increasing returns — MP rises (then may peak), AP rises. Fixed input underutilized; adding variable input increases efficiency. Ends where AP is maximum.
Stage II: Diminishing returns — MP falls but positive, AP falls after max. TP increases but at decreasing rate. Rational stage for firms.
Stage III: Negative returns — MP negative, TP falls. Overuse of variable input; inefficient.

Graphical illustration (TP, AP, MP curves):

Horizontal axis: Variable input (labor).
TP curve: Starts at origin, rises steeply (Stage I), then concave down (Stage II), peaks and falls (Stage III).
AP curve: Rises to max (end of Stage I), then falls.
MP curve: Rises above AP (Stage I), crosses AP at max AP, falls to zero (end Stage II), becomes negative (Stage III).

The firm typically operates in Stage II, where MP > 0 and diminishing but positive returns allow profit maximization (optimal input use where MP = wage in competitive markets).

(b) Use Iso-quant and Iso-cost curves to explain how a producer

(i) minimizes the cost of production for a given level of output,

(ii) maximizes output for a given cost.

Isoquant (IQ): Curve showing all combinations of two inputs (e.g., labor L, capital K) producing same output level (higher IQ = higher output). Convex to origin (diminishing marginal rate of technical substitution). Isocost (IC): Line showing all combinations of inputs costing the same total amount (C = wL + rK; slope = -w/r).

(i) Cost minimization for given output: Choose tangency point between a specific IQ (target output) and lowest possible IC. At tangency: Slope of IQ = slope of IC → MRTS = w/r (optimal input ratio). Any other point on IQ costs more.

(ii) Output maximization for given cost: Choose tangency point between a given IC (fixed budget) and highest possible IQ. Again, tangency ensures MRTS = w/r. Any other point on IC yields lower output.

4. (a) Suppose that a competitive firm has a total cost function C = 450 + 15q + 2q² and the marginal cost function MC = 15 + 4q. If the market price is P = ₹115 per unit, find the level of output produced by the firm and the level of profit.

In perfect competition, firm produces where P = MC (profit-maximizing condition, assuming P > AVC). Set P = MC:
115 = 15 + 4q
4q = 100
q = 25 units Profit = Total Revenue – Total Cost
TR = P × q = 115 × 25 = 2875
TC = 450 + 15(25) + 2(25)² = 450 + 375 + 2(625) = 450 + 375 + 1250 = 2075
Profit = 2875 – 2075 = ₹800(b) What is price discrimination? Explain the different degrees of price discrimination.
Price discrimination occurs when a firm charges different prices to different consumers for the same product, not due to cost differences, but to capture more consumer surplus and increase profits (requires monopoly power, ability to segment markets, prevent resale). Degrees:

First degree (perfect discrimination): Charge each consumer their maximum willingness to pay (e.g., personalized pricing). Captures entire consumer surplus; output same as perfect competition.
Second degree: Charge based on quantity purchased (e.g., bulk discounts, block pricing, two-part tariffs). Consumers self-select based on usage.
Third degree: Charge different prices to different groups/segments with different elasticities (e.g., student/senior discounts, peak/off-peak pricing). Most common; charges higher to inelastic group.

Section—B5.

(a) Given the demand and supply equations as Q_d = 150000 – 3P and Q_s = 7P, sketch the curves and (if any), calculate: (i) Consumer surplus (ii) Producer surplus (iii) Deadweight loss when unit tax of ₹5,000 per unit is levied.

First, find equilibrium without tax:
Set Q_d = Q_s → 150000 – 3P = 7P → 150000 = 10P → P = 15000, Q = 7×15000 = 105000 With unit tax ₹5000 (assume on sellers; supply shifts left): New supply Q_s’ = 7(P – 5000) = 7P – 35000 New equilibrium: 150000 – 3P = 7P – 35000 → 185000 = 10P → P = 18500 (buyers pay)
Q’ = 150000 – 3(18500) = 150000 – 55500 = 94500 (or 7(18500 – 5000) = 7×13500 = 94500)
Sellers receive P_s = 18500 – 5000 = 13500

(i) Consumer surplus (with tax): Area above P=18500 and below demand up to Q=94500. Triangle base 94500, height (max P on demand when Q=0: P=150000/3=50000) – 18500 = 31500. CS = (1/2)×94500×31500 ≈ very large, but calculate precisely later if needed — focus: reduced from pre-tax. Pre-tax CS = (1/2)×105000×(50000 – 15000) = (1/2)×105000×35000 = 1,837,500,000
Post-tax CS = (1/2)×94500×(50000 – 18500) = (1/2)×94500×31500 ≈ 1,488,375,000

(ii) Producer surplus (with tax): Area below P_s=13500 and above supply up to Q=94500. Pre-tax PS = (1/2)×105000×15000 = 787,500,000
Post-tax PS reduced (sellers get lower net price).

(iii) Deadweight loss: Loss in total surplus due to tax-reduced quantity (from 105000 to 94500). Triangle between demand/supply from Q=94500 to 105000. Height = tax = 5000. DWL = (1/2)×(105000-94500)×5000 = (1/2)×10500×5000 = 26,250,000 (b) Given the demand function Q_x = 8000 – 1000 P_x, determine the elasticity of demand at a single point, where price of ₹6 and the corresponding quantity of 2000 units.

First, verify point: Q = 8000 – 1000×6 = 8000 – 6000 = 2000 (correct). Point elasticity of demand (ε_d) = (dQ/dP) × (P/Q)
From demand: dQ/dP = -1000 (slope)
ε_d = -1000 × (6 / 2000) = -1000 × 0.003 = -3 (elastic; |ε| > 1)

6. (a) Discuss the law of equi-marginal utility.

The law of equi-marginal utility (or equi-marginal principle) states that a consumer maximizes total utility from limited income by allocating expenditure so that the marginal utility per rupee spent is equal across all goods: MU_x / P_x = MU_y / P_y = … = λ (marginal utility of money). If not equal, consumer can increase utility by shifting spending from lower MU/P good to higher MU/P good until equality. This explains consumer equilibrium in cardinal utility theory.

(b) What is an inferior good? Must the demand curve for an inferior good slope downward? Explain with the help of I.C. (indifference curve) analysis.

An inferior good is one whose demand decreases as income increases (negative income effect). Examples: low-quality staples when income rises. The demand curve usually slopes downward (negative price effect), but not always. Price effect = substitution effect + income effect. For inferior goods:

Substitution effect: always negative (buy less when price rises).
Income effect: positive (price rise = real income fall → buy more of inferior good).

If income effect > substitution effect in magnitude → positive price effect → Giffen good (upward-sloping demand). Indifference curve analysis: For normal goods, price fall shifts budget line outward, new tangency shows higher consumption. For inferior: income effect opposes substitution, but usually doesn’t overpower. For Giffen: strong positive income effect causes less consumption when price falls (rare, theoretical).

7. Explain the technique of splitting the price effect into its components of substitution and income effects for a Giffen good.

Price effect = total change in quantity due to price change = substitution effect + income effect. Technique (Slutsky or Hicksian decomposition):

Initial equilibrium: tangency of budget line and IC at point A (price P1, quantity Q1).
Price falls to P2 → new budget line, new equilibrium point C (quantity Q3 > Q1 for normal).
To isolate: Draw compensated budget line (parallel to new budget line but tangent to original IC at point B).
- Move from A to B: substitution effect (always negative for price fall → more quantity, Q2 > Q1).
- Move from B to C: income effect (real income increase due to price fall).

For Giffen good (inferior with strong income effect):

Substitution effect: increases quantity (A to B).
Income effect: decreases quantity strongly (B to C, Q3 < Q2).
Total price effect: negative quantity change despite price fall → upward-sloping demand.

Graphically: IC convex; for Giffen, final point C lies left of B on horizontal axis.

8. (a) Define expansion path.

Show graphically expansion path in case of linear homogeneous production function in the short-run and the long-run. Expansion path: Locus of points showing cost-minimizing (optimal) input combinations for different output levels (tangency points of successive isoquants and isocosts as output/cost increases). For linear homogeneous production function (constant returns to scale, homogeneous of degree 1):

Long-run: All inputs variable. Expansion path is a straight line through origin (input ratios constant; e.g., if Cobb-Douglas Q = K^a L^{1-a}, optimal K/L constant). Isoquants are radial blow-ups; tangency points form ray from origin.
Short-run: One input fixed (e.g., capital fixed). Expansion path is not straight — follows the fixed input level horizontally then curves as variable input increases (along the short-run production function). No ray from origin since proportions change.

Graphical note: Long-run: straight ray from origin in input space (K vs L). Short-run: vertical or horizontal segment (fixed input) with increasing variable input.

Here are detailed answers to the remaining questions from the economics exam paper. These build on standard microeconomic principles.

8. (b) Discuss the concept of long period economic efficiency.

Long-period economic efficiency (also called long-run efficiency) refers to the state where an economy or market achieves optimal resource allocation and production over an extended time horizon, when all inputs are variable and firms can fully adjust (enter/exit, change scale). It encompasses both allocative efficiency and productive efficiency in the long run, often with dynamic considerations. Key aspects:

Allocative efficiency: Resources are allocated such that the price (P) equals marginal cost (MC), reflecting that the value consumers place on the last unit (marginal benefit) equals the social cost of producing it. In the long run, this ensures no over- or under-production relative to societal preferences.
Productive efficiency: Firms produce at the minimum point of their long-run average cost (LRAC) curve, meaning output occurs at the lowest possible cost per unit (exploiting all economies of scale). No resources are wasted; firms operate at optimal scale.
In perfect competition, long-run equilibrium achieves both: free entry/exit drives economic profit to zero, firms produce where P = MC = minimum LRAC, ensuring maximum welfare (no deadweight loss).
In imperfect markets (e.g., monopoly), long-run efficiency is typically not achieved: P > MC (allocative inefficiency) and output below minimum LRAC (productive inefficiency/excess capacity in some cases).
Dynamic efficiency (a long-period extension): Over time, markets encourage innovation, technological progress, and cost reductions, improving efficiency further.

The long period allows full adjustment, making efficiency more complete than in the short period (where fixed costs limit adjustments). It maximizes societal welfare given scarce resources, assuming no externalities or other failures.

9. (a) A firm is operating at a loss. Explain why the firm might stay rather than exit the market.

A firm operating at a loss (negative economic profit) may choose to continue operating in the short run rather than exit (shut down) if it can cover its variable costs and contribute toward fixed costs.

In the short run, some costs are fixed (e.g., rent, machinery leases) and must be paid regardless of output. If the firm shuts down, output = 0, revenue = 0, and loss = total fixed costs (TFC).
If it produces, revenue may cover all variable costs (TVC) and part of fixed costs, making the loss smaller than TFC.
The shutdown rule: Continue if price (P) ≥ average variable cost (AVC) at the output level (or total revenue ≥ TVC). This minimizes losses.
If P < AVC, shut down immediately (losses would exceed TFC).
In the long run, if losses persist (even after covering all costs including opportunity costs), the firm exits permanently, as all costs become variable.

Thus, staying reduces short-run losses while hoping for market improvement (e.g., higher demand/price). Exit incurs additional costs (e.g., liquidation) and foregoes potential recovery.

(b) Distinguish between economic profit and accounting profit.

Accounting profit: Total revenue minus explicit costs (actual cash outflows like wages, rent, materials, interest). It is what appears on financial statements and is used for tax/reporting. It ignores opportunity costs.
- Formula: Accounting Profit = Total Revenue – Explicit Costs
- Positive accounting profit means the firm covers explicit costs and has money left.
Economic profit: Total revenue minus all costs, including explicit costs and implicit/opportunity costs (value of next-best alternative use of resources, e.g., owner’s time, forgone interest on capital).
- Formula: Economic Profit = Total Revenue – (Explicit Costs + Implicit Costs) = Accounting Profit – Implicit Costs
- Zero economic profit (normal profit) means the firm earns just enough to cover opportunity costs (resources are efficiently allocated; no incentive to leave/enter).
- Positive economic profit attracts entry; negative leads to exit in the long run.

Key difference: Accounting profit can be positive while economic profit is zero/negative (firm covers explicit costs but not opportunity costs, so it’s not truly “profitable” in economic terms).

10. Write short notes on any three of the following :

(a) Comparison of monopoly with perfect competition

Number of firms: Perfect competition — many small firms; Monopoly — single firm.
Product: Perfect competition — homogeneous (identical); Monopoly — unique (no close substitutes).
Price determination: Perfect competition — firms are price takers (P = market equilibrium); Monopoly — price maker (sets P where MR = MC, usually P > MC).
Output and price: Perfect competition — higher output, lower price (efficient); Monopoly — restricted output, higher price (deadweight loss).
Efficiency: Perfect competition — allocatively (P = MC) and productively efficient (minimum ATC in long run); Monopoly — inefficient (P > MC, possible excess capacity, no long-run minimum ATC pressure).
Profit: Perfect competition — zero economic profit in long run (entry/exit); Monopoly — positive economic profit possible (barriers to entry).
Welfare: Perfect competition maximizes total surplus; Monopoly creates deadweight loss (lost consumer/producer surplus).

Monopoly sacrifices efficiency for profit; perfect competition achieves maximum social welfare.

(b) Kinked demand curve analysis

The kinked demand curve explains price rigidity in oligopoly (few interdependent firms).

Assumption: Rivals match price decreases (to protect market share) but ignore price increases (to gain share).
Demand curve: Elastic above current price (price rise → large quantity loss as rivals don’t follow); Inelastic below (price fall → small gain as rivals match).
Kink at prevailing price → Marginal revenue (MR) has a vertical gap (discontinuity) at kink quantity.
Implication: MC can shift within the vertical MR gap without changing output/price → stable prices despite cost changes.
Explains observed rigid prices in oligopolies (e.g., airlines, telecom) but doesn’t explain initial price setting or why prices sometimes change.

(c) Ricardian theory of Rent

David Ricardo’s theory explains differential rent on land.

Rent = surplus from superior land over marginal (no-rent) land after applying equal labor/capital.
Assumptions: Land fixed/supply inelastic; fertility/location differences; diminishing returns.
As population grows/demand rises → cultivation extends to inferior land (marginal land pays no rent).
Rent on better land = difference in productivity (e.g., fertile land yields more output → rent = excess over marginal land).
Rent is not cost of production (price high → rent high, not vice versa).
Types: Extensive (fertility differences) and intensive (more inputs on same land).
Conclusion: Rent arises from scarcity and differential advantages; landlords benefit most from progress.

(d) Excess Capacity

In monopolistic competition (many firms, differentiated products, free entry), firms have excess capacity in long-run equilibrium.

Firms produce where MR = MC, but due to downward-sloping demand (some market power), output is left of minimum ATC.
Long-run: Entry drives economic profit to zero → tangency of demand with ATC (but not at minimum ATC).
Excess capacity = difference between actual output and output at minimum ATC (optimal scale).
Firms operate below efficient scale → higher average costs than perfect competition.
Trade-off: Excess capacity is the “cost” of product variety/differentiation (consumers benefit from choice).
Implication: Productive inefficiency (resources underutilized) but possible dynamic benefits (innovation from variety).

Section—C

11. What do you mean by market failure? Explain the sources of market failure.

Market failure occurs when the free market (price mechanism) fails to allocate resources efficiently, leading to a loss of economic welfare (deadweight loss or suboptimal outcomes). Resources are misallocated; too much/little of a good is produced relative to social optimum.Main sources:

Externalities: Costs/benefits not reflected in market prices (e.g., negative: pollution — overproduction; positive: education/vaccines — underproduction).
Public goods: Non-excludable and non-rivalrous (e.g., national defense, street lights) → free-rider problem; market underprovides or doesn’t provide.
Imperfect information: Asymmetric info leads to adverse selection (e.g., used cars) or moral hazard (e.g., insurance overuse).
Market power: Monopoly/oligopoly → P > MC, restricted output, deadweight loss.
Incomplete markets: Missing markets for risks/futures (e.g., no insurance for some events).
Inequality/equity issues: Market may produce efficient but unfair outcomes (not always “failure” but often considered).

Government intervention (taxes, subsidies, regulation) aims to correct these.

12. Define the fundamental role of the marginal cost in achieving efficiency in a perfectly competitive market

In a perfectly competitive market, the marginal cost (MC) plays a central role in achieving allocative efficiency and overall economic efficiency.

Firms are price takers → produce where P = MR = MC (profit maximization).
Price (P) reflects marginal benefit to consumers (willingness to pay for last unit).
MC represents marginal social cost of producing the last unit (resources used).
When P = MC, marginal benefit = marginal cost → resources allocated efficiently (no over/under-production; maximum total surplus).
In long run: Entry/exit ensures P = MC = minimum LRAC → productive efficiency (lowest cost per unit).
Thus, MC guides firms to socially optimal output: society gets goods where value equals production cost, eliminating deadweight loss.

MC ensures the “invisible hand” works: individual profit maximization leads to societal efficiency in perfect competition.