Indian Institute of Technology Madras (IIT-M) 2008 B.Tech Economics - Question Paper

Indian Institute Of Technology, Madras

Department of Humanities and Sciences

Quiz-I (Weightage: 20%) Date:16thFeb, 2008

HS431: Economics Time: 50min

1.      Explain what is meant by opportunity cost and the law of increasing costs? Illustrate these concepts with the use of a production possibilities curve.

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Ans:

Opportunity cost: the cost of something is what you give up to get it e.g. the opportunity cost of increasing the production of cars from 600 to 700 is 200 computers.

The Law of increasing opportunity cost: The shape of the production possibilities frontier indicates that the opportunity cost of cars in terms of computers increases as the country produces more cars and fewer computers. This occurs because some resources are better suited to the production of cars than computers (and vice versa).

2.      Draw the circular flow of economic activity, labeling all actors, markets, and flows. Point out where capitalism answers the questions of 'what,' 'how,' and 'to whom,' and explain how it does so at the places indicated on your drawing.

Ans:

3.      Define the law of demand and list the variables that determine the quantity demanded. Illustrate a shift in demand and discuss what things might cause the demand curve to shift.

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Ans: Law of Demand: other things being equal, the quantity demanded of a good falls when the price of the good rises.

a.       Price

b.       Income

c.        Prices of Related Goods

d.       Tastes

e.        Expectations

Shift in demand may be due to a change in any of the factors mentioned except the price of the goods/services under discussion.

4.      List and discuss the determinants of the elasticity of demand. Illustrate with the use of graphs and then explain the relationship between Total Revenue and

a.       elastic demand curves;

b.      inelastic demand curves.

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Ans: Price Elasticity of Demand: a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.

Determinants of Price Elasticity of Demand:

a.           Necessities versus Luxuries: necessities are more price inelastic.

b.           Availability of Close Substitutes: the more substitutes a good has, the more elastic its demand.

c.            Definition of the Market: narrowly defined markets (ice cream) have more elastic demand than broadly defined markets (food).

d.           Time Horizon: goods tend to have more elastic demand over longer time horizons.

1.                 If demand is inelastic, the change in price will be greater than the change in quantity demanded.

a.         If price rises, quantity demanded falls, and total revenue will rise (because the increase in price was larger than the decrease in quantity demanded).

b.         If price falls, quantity demanded rises, and total revenue will fall (because the fall in price was larger than the increase in quantity demanded).

2.                 If demand is elastic, the change in quantity demanded will be greater than the change in price.

a.        If price rises, quantity demanded falls, and total revenue will fall (because the increase in price was smaller than the decrease in quantity demanded).

b.        If price falls, quantity demanded rises, and total revenue will rise (because the fall in price was smaller than the increase in quantity demanded).

5.      Which of the following statements are examples of positive economic analysis? Which are examples of normative analysis?

a.       The 0.5% hike in CRR by RBI would cause a moderate decrease in the availability of money and hence reduce the rate of inflation.

b.      The left parties are threatening the UPA government that they would withdraw support if the Government deviates from the Common Minimum Program (CMP).

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Ans: The first statement is positive while the second one is a normative one.

6.      Who benefits from a binding price ceiling? Who is hurt by a binding price ceiling?

Ans: The consumer benefits from the binding pricing ceiling, whereas the producers are hurt as he is getting lesser than the market price.

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7.      Choose the appropriate word from the block and fill in the gaps in the paragraph below, to give a good description of how a market economy allocates resources.

A market economy uses prices_as the principal means of allocating resources. Prices are determined by the interaction of demand_and _supply . Consumers express their preferences through their demand for goods and services. This is known as _ consumer sovereignty _. If consumers increase their purchases of a good and the level of demand_exceeds supply then prices will tend to rise. This will make the production of this good more profitable and attract more   firms into the market. This extra _supply of the good will bring prices down and restore _equilibrium in the market. If markets work perfectly throughout the economy, then this should ensure _allocative efficiency_.

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