THEORY OF DEMAND , SUPPLY , PRODUCTION AND COST

What is the difference between a Change in Quantity Demanded and a Change in Demand?

• Change in Quantity Demanded is movement along the same demand curve.
• It occurs only because of a change in price.
• Change in Demand is a shift of the entire demand curve.
• It occurs because of non-price factors like income, tastes and preferences.
• Expansion and Contraction refer to Quantity Demanded.
• Increase and Decrease refer to Demand.

What is Arc Elasticity of Demand and when is it used?

• Used when price changes are large.
• Measures elasticity between two points on the demand curve.
• Uses the midpoint of price and quantity.
• Provides a more accurate elasticity for large changes.

What does the sign of Cross Elasticity of Demand indicate?

• Positive value → Substitute goods.
• Example: Tea and Coffee.
• Negative value → Complementary goods.
• Example: Pen and Ink.
• Zero → Unrelated goods.

True or False: All Giffen Goods are Inferior Goods, but not all Inferior Goods are Giffen Goods.

• True.
• Giffen goods are a special type of inferior goods.
• Strong negative income effect dominates the substitution effect.
• Demand curve slopes upward.

Differentiate between the Bandwagon Effect and the Snob Effect.

• Bandwagon Effect → Demand increases because others are buying the product.
• Snob Effect → Demand decreases because others are buying the product.
• Bandwagon is driven by popularity.
• Snob is driven by exclusivity.

What is the Total Outlay Method for measuring Price Elasticity of Demand?

• Price and Total Revenue move in opposite directions → Elastic Demand.
• Total Revenue remains unchanged → Unitary Elastic Demand.
• Price and Total Revenue move in the same direction → Inelastic Demand.

What are the conditions for Consumer Equilibrium under Marginal Utility Analysis?

• Marginal Utility equals Price multiplied by Marginal Utility of Money.
• Marginal Utility should be diminishing.
• Consumer is in equilibrium when no further gain is possible by changing consumption.

What is Consumer Surplus?

• Difference between what a consumer is willing to pay and what is actually paid.
• Consumer Surplus = Total Utility − (Price × Quantity).
• Graphically, it is the area below the demand curve and above the price line.

What are the four properties of an Indifference Curve?

• Downward sloping.
• Convex to the origin.
• Higher Indifference Curves give higher satisfaction.
• Two Indifference Curves never intersect.

Mnemonic:
CD-NO

What are the conditions for Consumer Equilibrium under Indifference Curve Analysis?

• Marginal Rate of Substitution equals the price ratio.
• The Indifference Curve must be convex to the origin.
• Consumer reaches the highest possible satisfaction within the budget.

What is the shape of an Indifference Curve for Perfect Substitutes and Perfect Complements?

• Perfect Substitutes → Straight downward-sloping line.
• Perfect Complements → Right-angled or L-shaped curve.

How does Price Elasticity of Supply change over different time periods?

• Market Period → Perfectly Inelastic.
• Short Period → Relatively Inelastic.
• Long Period → Relatively Elastic.

What are the three stages of the Law of Variable Proportions?

• Stage 1 → Average Product rises and reaches its maximum.
• Stage 2 → Average Product falls, Marginal Product remains positive, Total Product continues increasing.
• Stage 3 → Marginal Product becomes negative and Total Product declines.

Which stage of the Law of Variable Proportions is called the Stage of Rational Operation?

• Stage 2.
• Fixed factors are efficiently utilized.
• Marginal Product is positive.
• Rational producers operate in this stage.

What is the Point of Inflexion on the Total Product Curve?

• Point where Total Product changes from increasing at an increasing rate to increasing at a decreasing rate.
• Marginal Product reaches its maximum at this point.

What is the relationship between Average Product and Marginal Product?

• When Marginal Product is greater than Average Product, Average Product rises.
• When Marginal Product equals Average Product, Average Product is maximum.
• When Marginal Product is less than Average Product, Average Product falls.

Differentiate between the Law of Variable Proportions and the Law of Returns to Scale.

• Law of Variable Proportions applies in the short run.
• At least one factor remains fixed.
• Law of Returns to Scale applies in the long run.
• All factors change in the same proportion.

What is the Cobb-Douglas Production Function?

• Shows the relationship between inputs and output.
• Constant Returns to Scale exist when the exponents add up to one.
• Labour generally receives about 75% of output.
• Capital generally receives about 25% of output.

What is an Isoquant Curve?

• Shows different combinations of inputs producing the same output.
• Its slope represents the Marginal Rate of Technical Substitution (MRTS).
• Similar to an Indifference Curve for production.

Differentiate between Economic Cost and Accounting Cost.

• Accounting Cost includes only explicit costs.
• Economic Cost includes explicit and implicit costs.
• Economic Cost considers opportunity cost.
• Economic Profit = Total Revenue − Economic Cost.

What are Sunk Costs?

• Costs already incurred.
• Cannot be recovered.
• Should be ignored while making future business decisions.

What is the relationship between Total Cost, Total Fixed Cost and Total Variable Cost?

• Total Cost = Total Fixed Cost + Total Variable Cost.
• Total Fixed Cost remains constant.
• Total Variable Cost changes with output.
• Difference between Total Cost and Total Variable Cost always equals Total Fixed Cost.

What is the relationship between Average Cost and Marginal Cost?

• When Marginal Cost is less than Average Cost, Average Cost falls.
• When Marginal Cost equals Average Cost, Average Cost is minimum.
• When Marginal Cost is greater than Average Cost, Average Cost rises.
• Marginal Cost reaches its minimum before Average Cost.

Why is the Long-Run Average Cost Curve called the Envelope Curve and Planning Curve?

• Envelope Curve because it touches many Short-Run Average Cost curves.
• Planning Curve because firms use it to choose the best plant size.
• It helps determine the lowest long-run production cost.

Why are the Short-Run Average Cost and Long-Run Average Cost curves U-shaped?

• Short-Run Average Cost is U-shaped because of the Law of Variable Proportions.
• Long-Run Average Cost is U-shaped because of economies and diseconomies of scale.

Differentiate between Internal Economies and External Economies of Scale.

• Internal Economies arise due to expansion of a single firm.
• External Economies arise due to expansion of the entire industry.
• Internal Economies benefit one firm.
• External Economies benefit all firms.

Match the Elasticity of Demand values with the shape of the Demand Curve.

• Elasticity = 0 → Vertical Demand Curve.
• Elasticity = Infinity → Horizontal Demand Curve.
• Elasticity = 1 → Rectangular Hyperbola.

When does a competitive firm shut down in the short run?

• When Price falls below Average Variable Cost.
• The firm cannot cover variable costs.
• Fixed costs are still incurred.
• Production should stop temporarily.

What is the relationship between Marginal Revenue and Price Elasticity of Demand?

• When Elasticity equals 1, Marginal Revenue is zero.
• When Elasticity is greater than 1, Marginal Revenue is positive.
• When Elasticity is less than 1, Marginal Revenue is negative.
• Marginal Revenue depends on Price Elasticity of Demand.

How does Average Fixed Cost behave as output increases?

• Average Fixed Cost continuously falls as output increases.
• Its curve is a Rectangular Hyperbola.
• It approaches the X-axis but never touches it because Total Fixed Cost always remains positive.