AP Inter 1st Year Economics Important Questions Chapter 5 Theory of Value

Students must practice these AP Inter 1st Year Economics Important Questions 5th Lesson Theory of Value to boost their exam preparation.

AP Inter 1st Year Economics Important Questions 5th Lesson Theory of Value

Long Answer Questions

Question 1.
Explain the classification of Markets. [May, March – 2018, 2017]
Answer:
The term market generally refers to a place, where buyers and sellers meet and where the exchange or buying and selling of goods take place.

According to Beham, the market can be defined as “Any area over which buyers and sellers are in, such arrangement (close touch) with each other directly or through dealers, so that the price obtainable in one part of the market affect the price paid in other parts”.

Classification of markets:
1) Basing on Competition:
a) Perfect markets: Perfect markets are those markets where there are conditions of perfect competition, like large number of buyers and sellers, homogeneous good, uniform or single price, etc.

b) Imperfect markets: Imperfect markets are those markets where there are conditions of imperfect competition, like single / two / few sellers, differentiated products, different prices, etc.

2) Basing on Area:
a) Local market: A market with few sellers and few buyers covering a limited geographical area with limited demand and limited supply is called local market. Eg: Village market for perishable goods like milk, vegetables, etc.

b) National market: A market with sellers and buyers spread/located throughout the country and with demand and supply spread throughout the country is known as a national market. Eg. Market for durable goods like sugar, wheat, cotton, etc,

c) International market: A market with demand and supply spread throughout the world and purchases and sales taking place with global buyers and global sellers, at the international level is known as the international market or global market.

3) Basing on Time:
a) Very short period market: It is a market relating to very short period time (less than 1 day) in which supply is absolutely fixed or constant. In this market, demand plays, all or very important role in the fixation of price in the market.

b) Short period market: It is a market relating to a short period (covering a time period of more than 1 day, but up to 1 year) of time. In this market, supply can be changed partially by making changes in variable inputs. In this market, in the fixation of price demand plays a greater role than supply.

c) Long period market; It is a market covering/relating to a long period of time (covering a time period of more than 1 year) in which supply can be fully adjusted by making changes both in fixed inputs and variable inputs. In this market, in the fixation of price, supply plays more important role than demand.

Question 2.
Elucidate the features of perfect competition. [May 2016]
Answer:
Perfect competition is an important type of competition. If the conditions relating to perfect competition are satisfied or exist in the market, there is said to be perfect competition in the market.

Characteristic features of perfect competition:
1) a Large number of sellers and buyers: An important condition of perfect competition is the existence of large number of sellers/firms and buyers in the market. As there are large numbers of firms in the market, each firm will have a very small share in the market. So no individual firm in the market can influence the price in the market. All the firms can sell any quantity at the same price or at price given by the industry.

2) Homogeneous product: In perfect competition, all the firms produce homogeneous or identical products. As all the firms are producing homogeneous products, there will be the uniform price in the entire market. There is no possibility of more than one price prevailing in the market.

3) Free entry and exit: There is the freedom for new firms to freely enter the market. When existing firms earn super-normal profits, new firms enter the market. Similarly, if the existing firms are incurring losses, they can leave the market. But such freedom of entry and exit are possible only in the long run, but not in the short run.

4) Perfect knowledge of market conditions: In perfect competition, buyers and sellers have full information about the conditions in the market. Buyers and sellers know the price, total demand and total supply for the product and where the product is available. In the same way, sellers also know full information about total demand, the prevailing price, etc.

5) Perfect mobility of goods and factors of production: In perfect competition, output or goods can be moved or transported from one place to another. Similarly, factors of production can move from one firm to another firm, from low-paying units to high-paying units.

6) Absence of transport costs: In perfect competition, goods can be transported or moved from one place to another place in the market. But such transport is cost free or free of cost. So, even though the goods are transported over long distances from one corner of the market to another, the same or uniform price prevails throughout the market/industry.

7) Uniform price: In perfect competition, there will be only a single or uniform price throughout the market. This is because all the firms produce homogeneous products and they have to follow the price determined by the industry/ market.

8) No publicity cost: As all the firms are producing homogeneous products, there is no need for advertisement and publicity.

9) AR and MR curves: In perfect competition, the AR curve, which is also MR curve, is parallel to X – axis. This is because in perfect competition firms have to sell any quantity or any number of units at the same price.

Question 3.
Describe the price determination in perfect competition. [Mar. 19 (AP&TS); (V.Imp)]
Answer:
Perfect competition is one of the important types of competition. The following are the conditions of perfect competition.
1) a large number of sellers and buyers: An important condition of perfect competition is the existence of large number of firms or sellers and buyers in the market. All the firms can sell any quantity at the same price.

2) Homogeneous product: In perfect competition, all the firms produce homogeneous or identical products. As all the firms are producing homogeneous products, there will be uniform or single price in the entire market.

3) Free entry and exit: There is the freedom for new firms to freely enter the market. When existing firms earn super-normal profits, new firms enter the market. Similarly, if the existing firms are incurring losses, they can leave the market. But such entry and exit are possible only in the long run, but not in the short run.

4) Perfect knowledge of market conditions: In perfect competition, buyers and sellers have full information about the conditions in the market. Buyers and sellers know the price, total demand and total supply for the product and where the product is available.

5) Perfect mobility of goods and factors of production: In perfect competition, output or goods can be moved or transported from one place to another. Similarly, factors of production can move from one firm to another firm, from low-paying units to high-paying units.

6) Absence of transport costs: In perfect competition, to transport goods from one place to another, there are no transport costs, so, there will be a uniform price in all market area.

7) Uniform price: There will be only single or uniform price in the entire market area,

8) No publicity costs: As all the firms are producing homogeneous products, there is no need for advertisement and publicity.

9) The AR Curve: In perfect competition, the AR curve, which is also MR, is parallel to X-axis. This is because in perfect competition, all firms have to sell any quantity or any number of units at the prevailing or the same price.

In perfect competition, price is not determined by a single firm. It is determined by the industry based on total demand and total supply of the commodity in the market.

Price determination in perfect competition can be known with the following table and diagram.
AP Inter 1st Year Economics Important Questions Chapter 5 Theory of Value 1
AP Inter 1st Year Economics Important Questions Chapter 5 Theory of Value 2

In the above diagram on Y – axis, the price is shown and on X – the axis is supply and demand are shown. At a price of Rs. 3 the demand (40 kgs) is equal to the supply (40 kgs). This price is called equilibrium price and quantity is equilibrium quantity because at that price both demand, and supply are equal to each other. (40 kgs)

When price is very high (Rs. 5) supply (60 kgs) is more than the demand (20 kgs). So, the competition among sellers or excess supply brings down the price to Rs. 3, where both demand and supply are equal to each other.

If the price is very low at Rs. 1, demand (60 kgs) is more than supply (20 kgs). So, the competition among the buyers or excess demand pushes up the price to Rs. 3, where both demand and supply are equal to each other. So the price Rs. 3 is the equilibrium price and 40 kgs is the equilibrium output.

Note to the students: Students are advised to write only the side headings of the features of perfect competition while answering this question in Intermediate Public Examination.

Question 4.
Explain the features of monopolistic competition.
Answer:
Monopolistic competition is a combination of perfect competition and monopoly. It can be described as the competition among a group of firms/monopolists producing slightly differentiated products.

Features:
1) Large number of sellers: As in perfect competition, in monopolistic competition also, the sellers/firms are large in number. Each firm does have a small share in the market and cannot control of output in the market.

2) Product differentiation; A very important feature of monopolistic competition is product differentiation. Such differentiation may be real or artificial.

3) Freedom of entry and exit: In monopolistic competition, firms enjoy the freedom of entry and freedom of exit. New firms can enter the market and existing firms can leave the market at their will.

4) Selling costs and advertisement: In monopolistic competition, there is severe competition among the firms. So, firms spend huge amounts on advertising and publicity to attract customers.

5) Imperfect knowledge: In monopolistic competition, buyers do not have complete information about the goods available and their quantity. They feel that some goods are superior to others even though there are only slight differences.

6) Price decision: In monopolistic competition, firms producing slightly differentiated goods can determine the prices of their products independently, with a given price range.

7) Nature of demand curve: A firm under monopolistic competition will have a downward-sloping demand curve, but such a demand curve is relatively elastic (not fully elastic and not fully inelastic.)

Question 5.
Define Monopoly. (What is Monopoly ?) How are price-output determined * under monopoly? (V.Imp)
Answer:
The term monopoly is derived from a Latin word “Mono” and “Poly”, meaning thereby a single seller. A monopoly is a market form in which there is a single seller or firm, producing and selling the product without close substitutes.
According to Prof. Dooley “A monopoly is a market with one seller”.

Features of monopoly: The features of monopoly are as below.
1) Single firm dr seller: In a monopoly, there is a single seller or firm. So, the total supply is controlled by that single firm or seller. There is no difference between a firm and an industry.

2) No close substitutes: There are no close substitutes to the product of the monopolist. So, even if the price is increased, the consumers have to purchase the same product because there are no close substitutes.

3) Price maker: The monopolist can determine the price of his product independently as he controls the entire supply in the market.

4) A monopolist cannot determine the supply and price at the same time: He can fix only one. If he fixes the price, the quantity to be purchased is determined by buyers. If he wants to sell a larger quantity, he has to gradually reduce the price.

5) Downward and sloping demand curve: The demand curve of the monopolist slopes downwards from left to right. It means that he can sell more quantity only by reducing the price.

Price determination in monopoly: A monopolist has to reduce the price of the product in order to sell larger quantity. This means his demand curve is downward sloping. When AR decreases, MR also decreases. But the fall in marginal revenue is more than the fall in the average revenge. In other words, the marginal revenue curve will be below the average revenue curve.

A monopolist earns a maximum profit when he reaches equilibrium. Equilibrium can be reached when

  1. Marginal cost is equal to marginal revenue
  2. Marginal cost curve should intersect the marginal revenue curve from below.

The equilibrium of a monopolist can be shown with the help of the following diagram.
AP Inter 1st Year Economics Important Questions Chapter 5 Theory of Value 3

In the above diagram, on Y – axis, price, revenue and cost are shown and on X – axis output is shown. AR is the average revenue curve and MR is the marginal revenue curve of the monopolist. At point A, marginal cost is equal to marginal revenue and the margined cost is cutting marginal revenue from below. At point A, the average revenue curve (AR) is CQ or OP per unit and the average cost is BQ per unit. CB is the supernormal profit per unit. Total profit is equal to CB x OQ, equal to the shaded area of the rectangle PCRB.

So, the monopolist, at the equilibrium point, sells OQ output at a price of CQ or OP per unit. The total supernormal profit earned by the Monopolist is the area of the rectangle PCRB.

Short Answer Questions

Question 1.
What are the main features of perfect competition?
Answer:
A market in which only one prevails for the same commodity is called perfect competition.

Definitions: According Marshall, “Perfect competition is a market in which the same price is to be paid for the same commodity at the same time in all parts of the market.”

According to Bilas, “Perfect competition is characterized by the presence of many firms. All of them sell identical products. The seller is the price taker.”

The following are main features of perfect competition.

  1. a Large number of buyers and sellers
  2. Homogeneous product
  3. Uniform or single/same price in the market
  4. Freedom of entry and freedom of exit
  5. Perfect mobility of goods and factors of production
  6. Perfect knowledge about market conditions
  7. Absence of transport costs or no transport costs
  8. No selling and public costs
  9. AR and MR curves being parallel to X – axis.

Question 2.
What is meant by price discrimination? Explain various methods of price discrimination.
Answer:
Price discrimination is a policy followed in a monopoly, in which a monopolist charges different prices for the same goods, at the same time, in the same place or market from different customers. In other words, price discrimination means charging different prices from different buyers for the same good.

Methods of price discrimination:
a) Personal price discrimination: In this method, the monopolist charges different prices from different customers for the same good.
Eg: A doctor may charge less/no fees from a poor person arid higher fees from a rich person.

b) Use discrimination: Under this method, different prices are charged for different uses for the same good.
Eg: the Electricity board charges lower unit rate for agriculture from farmers and a higher unit rate from industries.

c) Discrimination between markets: In this method, the market is divided into two parts, basing on distance and demand, and two different prices are charged in those sub-markets. Eg:A company may charge a higher price to its good in the domestic market and a lower price for the same good in the foreign market.

Question 3.
Define Oligopoly.
Answer:
An important form of imperfect competition is an oligopoly. The term oligopoly is described as “competition among few.” In other words, when there are few sellers (abound 3 – 6) in the market selling homogeneous or differentiated products, an oligopoly is said to exist.
Prof. Stigler defines Oligopoly as that “situation in which firm bases its market policy in part on the expected behavior of a few close rivals.”

The important features of Oligopoly are:

  1. Interdependence
  2. Importance of advertising and selling costs
  3. Group behaviour
  4. Indeterminateness of the demand curve facing the oligopolist (kinked demand curve).

Question 4.
Compare perfect competition and monopoly.
Answer:
Perfect competition is a market in which the same price is to be paid for the same commodity at the same time in all parts of market.
But monopoly is a market situation in which there is a single firm/seller in the market producing and selling the goods without any close substitutes and without competition.

Comparison: (Differences)

Perfect competition Monopoly
1. Large number of sellers 1. Only single seller in the market
2. The goods of all firms are homogenous and are perfect replacements. 2. No homogeneity and no close substitutes to each other.
3. There is freedom of entry and freedom of exit to firms. 3. No freedom of entry because the monopolist prevents the entry of new firms.
4. Firm and industry are separate and different. 4. No difference between firm and industry. Firm and industries are the same.
5. Industry is the price maker and the firms are the price takers. 5. Monopolist himself can determine the price in the market.
6. Uniform or single price prevails/exists in the market. 6. Possibility of price discrimination or two prices to the good is possible.
7. In perfect competition, price, AR, and MR are the same and such a line is parallel to X – axis. 7. In monopoly, AR and MR are two separate lines. Both are downward sloping with MR being lower than AR.
8. In perfect competition price is lower and output is larger than in a monopoly. 8. In a monopoly, price is higher and output is less than in perfect competition.
9. In perfect competition, the demand curve of the firm is perfectly elastic and such a demand curve is a horizontal straight line parallel to X – the axis. 9. Demand curve of the monopolist slopes downwards from left to right.
10. In perfect competition, firms can earn supernormal profits only in the short run and not in the long run. 10. A monopolist can earn supernormal profits both in the short run and in the long run.

Very Short Answer Questions

Question 1.
Market. [Mar. 19 (AP)]
Answer:
The term ‘market’ refers to a place where buyers and sellers meet and where exchange of goods or buying and selling of goods take place. Nowadays market need not be confined to a locality. In Economics, the term ’market’ not only refers to a place where goods are bought and sold, but also refers to a product.

Question 2.
Local Market.
Answer:
A market which covers a limited geographical area like a small village, is known as local market. In a local market, the number of buyers and sellers is very small and the quantity bought and sold is also very small. All perishable goods, normally will have local markets.

Question 3.
National Market.
Answer:
A product is said to have national market when the demand and supply of the good are spread all over the nation. It is a market which covers the entire area in the country and buyers and sellers are located throughout the country. Generally, all durable consumer goods and industrial goods will have national market.

Question 4.
Monopoly. [Mar. 19 (TS); May 2017]
Answer:
Monopoly is a market situation where there is a single seller/iirm, producing and selling the good in the market. There are no close substitutes to the product of the monopolist and no competition to the monopolist. He fixes the price of his product and controls the entire supply in the market.

Question 5.
Monopolistic competitions.
Answer:
Monopolistic competitions is a market situation in which there are large number Of sellers producing slightly differentiated products. It is a mixture or combination of perfect competition and monopoly. In monopolistic competition, each seller is having his own demand or customers but they have to compete with other sellers producing close substitutes. In monopolist competition, there is a lot of importance for brand names, advertising and selling costs.

Question 6.
Oligopoly.
Answer:
A market where there are few sellers (3 or 4 firms-or sellers’) is known as oligopoly. Such firms may produce either homogeneous good or differentiated product. There is severe competition and close interdependence among the firms in the market. There is a lot of uncertainty among the firms in the market.

Question 7.
Duopoly.
Answer:
A market where there are two sellers or firms is known as duopoly. As there are only two firms in the market, each firm or seller will have comparatively large share in the market. In duopoly, there is close interdependence betweenfirms and a lot of uncertainty in the behaviour of sellers.

Question 8.
Equilibrium Price.
Answer:
Equilibrium price refers to that/such price at which both demand and supply are equal to edch other.

Question 9.
Price Discrimination. [Mar. 19 (AP); May, March – 2018, 2017]
Answer:
Price discrimination is an important policy of monopoly in which the monopolist sells at or changes different prices for the same good, from different customers, in the same market and at the same time.

Question 10.
Selling costs. [Mar. ’19 (TS); May, Mar. ’18; May. 16, Mar. ’17]
Answer:
Selling costs mean the costs incurred by business firms towards attracting customers and for the sale of the goods. Eg: Advertising and publicity costs, free sampling, etc. Selling costs are very important in monopolistic competition and in oligopoly where there is severe or intense competition among the firms.

Question 11.
Equilibrium of a firm.
Answer:
Equilibrium means a state of no change. A business firm reaches its equilibrium when the following two conditions are satisfied.

  1. Marginal cost should be equal to marginal revenue
  2. Marginal cost curve should intersect or cut marginal revenue curve from below.

Question 12.
Product differentiation.
Answer:
Product differentiation means the differences in the products produced and sold by business firms in the market. An important feature of monopolist competition is product differentiation. Such differentiation may be either real or artificial/imaginary. The firms in monopolistic competition enjoy monopoly power through such product differentiation.

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