Ignou solved assignment eec 11 2014 to 2015 (demo)

Section-A
Long Answer Questions. (Answer in about 500 words each) 2X20=40
Q.N.1. Distinguish (with graphical illustration) between price elasticity of Demand and cross elasticity of demand.
How can you measure the elasticity of demand? Explain with example how the concept of elasticity of demand is
useful for an industry in its decision making process?
Ans: Difference between Price and Cross Elasticity of Demand
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2. Whatare the advantages of International trade? Explain Heckscher-Ohlin’s(version) approachofinternational
trade.
Ans: International trade and Its advantages
International trade referstothe exchange of goodsandservicesbetweenone countryorregionand another.
It isalso sometimes known as “inter-regional” or “foreign” trade. Briefly, trade between one nation and another is
called “international” trade, and trade within the territory (political boundary) of a nation “internal” trade.
Advantages of International Trade:
(1) OptimumAllocation:International specialisationandgeographical divisionof labourleadstothe optimum
allocation of world’s resources, making it possible to make the most efficient use of them.
(2) Gainsof Specialisation:Eachtrading country gains when the total output increases as a result of division
of labour and specialisation. These gains are in the form of more aggregate production, larger number of varieties
and greater diversity of qualities of goods that become available for consumption in each country as a result of
international trade.
(3) Enhanced Wealth:Increase inthe exchangeable value of possessions,meansof enjoyment and wealth of
each trading country.
(4) Larger Output: Enlargement of world’s aggregate output.
(5) Welfare Contour: Increase in the world’s prosperity and economic welfare of each trading nation.
(6) Cultural Values: Cultural exchange and ties among different countries develop when they enter into
mutual trading.

(7) Better International Politics: International trade relations help in harmonising international political
relations.
Heckscher-Ohlin’s (version) approach of international trade
The Modern Theoryof international trade hasbeenadvocatedbyBertil Ohlin.Ohlinhasdrawnhisideasfrom
Heckscher'sGeneral EquilibriumAnalysis.Hence itisalsoknownasHeckscher Ohlin (HO) Theory. According to Bertil
Ohlin, trade arisesdue tothe differencesinthe relative pricesof differentgoodsindifferentcountries.The difference
incommodityprice isdue to the differenceinfactorprices(i.e.costs).Factorpricesdiffer because endowments (i.e.
capital and labour) differ in countries. Hence, trade occurs because different countries have different factor
endowments.The HeckscherOhlintheoremstatesthatcountrieswhich are richinlabourwill export labourintensive
goods and countries which are rich in capital will export capital intensive goods.
Assumptions of Heckscher Ohlin's H-O Theory
Heckscher-Ohlin's theory explains the modern approach to international trade on the basis of following
assumptions :
1. There are two countries involved.
2. Each country has two factors (labour and capital).
3. Each country produce two commodities or goods (labour intensive and capital intensive).
4. There is perfect competition in both commodity and factor markets.
5. All production functions are homogeneous of the first degree i.e. production function is subject to
constant returns to scale.
6. Factors are freely mobile within a country but immobile between countries.
7. Two countries differ in factor supply.
8. Each commodity differs in factor intensity.
9. There are no transportation costs.
Giventhese assumption, Ohlin's thesis contends that a country export goods which use relatively a greater
proportion of its abundant and cheap factor. While same country import goods whose production requires the
intensive use of the nation's relatively scarce and expensive factor.
In the twocountries, two commodities & two factor model, implies that the capital rich country will export
capital intensivecommodityandthe labourrichcountry will export labour intensive commodity. But the concept of
countrybeingrichin one factor or otherisnot veryclear.Economistsquite oftendefinefactorabundance interms of
factor prices. Ohlin himself has followed this approach. Alternatively factor abundance can be defined in physical
terms. In this case, physical amounts of capital & Labour are to be compared.
Section-B
MediumAnswerQuestions.(Answerin about 250 words each) 4X12=48
Q.N.3. What do you mean by ‘National Income’? Explain how production flow, income flow and expenditure flow
in an economy are related to each other?
Ans:National income isan uncertaintermwhichisusedinterchangeablywithnationaldividend,national output and
national expenditure. On this basis, national income has been defined in a number of ways. In common parlance,

national income meansthe total value of goodsandservicesproducedannuallyinacountry. Inotherwords,the total
amount of income accruing to a country from economic activities in a year’s time is known as national income. It
includes payments made to all resources in the form of wages, interest, rent and profits.
Accordingto Marshall:“The labourandcapital of a countryacting on itsnatural resourcesproduce annuallya
certain net aggregate of commodities, material and immaterial including services of all kinds. This is the true net
annual income or revenue of the country or national dividend.”
Relationship between production flow, income flow and expenditure flow
There are four main sectors or groups of participants in an economy: the households, firms, government and
foreign sector. Moreover, there are two main sets of markets in an economy: the markets for goods and services
(simply called goods markets) and the markets for the various factors of production (the factor markets). These
sectors and markets are interrelated through the processes of production, income and spending. For example,
householdssell their factors of production on the factor markets and then use their income to purchase goods and
services on the goods markets. Firms, on the other hand, purchase factors of production on the factor marke ts and
thencombine these factors to produce goods and services which are then sold on the goods markets. Government
extractsincome fromhouseholdsandfirmsthroughtaxationandpurchase goods, services and factors of production
in the goods and factor markets. As far as the foreign sector is concerned, part of the domestic production is
exported to other countries, while other goods and services are imported to satisfy domestic needs. This can be
understood with the help of the following diagram
Q.N.4. Distinction between law of returns and returns to scale
Ans:The lawof diminishingreturnsonlyappliesinthe ShortRun,when only one factor of production is variable and
can be increased.The otherfactorsof productionare fixed.Thusasthe variable factorof production is increased the
marginal product of that factor will rise at first, but will at some point begin to fall.
Returnsto scale can onlyoccur whennofactors of production are fixed. If the quantities of all of the factors
of productionare increased,thenoutputwill alsoincrease.However,the amountbywhichoutputrisescan either be
proportionatelymore thanthe amountthat the factorsof productionwere increasedby,proportionately less, or the
same. These cases are called increasing returns to scale, decreasing returns to scale, or constant returns to scale.
Reasons for operation of the law of diminishing return:
(i) Inelasticity (fixity) supply of some factors: It is the fixity of the supply of land which sets the law of
diminishing return in motion. In short period some factors are fixed and given. When other variable factors are
combinedwiththisfactorinincreasingproportions,thisfixedfactorisdistributeonthe unitsof variable factors.After
an ideal combinationthe proportionof variablefactorsto fixed factors become high. That is why diminishing return
occurs.
(ii) Imperfectsubstitutes:AccordingtoMrs. JoanRobinsonthe factorsof productionare imperfectsubstitute
for one another.Capital canbe substituted for labour to some extent but cannot do perfectly. If these factors were
perfectsubstitutesforone another,the returnswouldnot diminish. The greater the imperfection in substitution of
one factor for another, the faster shall be the fall in marginal return.
(iii) OptimumProportion: Factorsare combinedina proportionwhichisgiven.Noothercombination will be
more efficient than this. If this proportion is disturbed, the efficiency of factors will fall giving rise to diminishing
returns.

Q.N.5. (a) State the relationshipbetweenAverage Costand Marginal Cost.
(b) From a givencost function: TC = 60 + 0.5q + 0.3q2
Findout FixedCost,Average Variable Cost and Marginal Cost
Q.N.6. What is propensity to consume (MPC)? Explain with example and diagram how MPC influences the
multiplier?
Ans: Marginal Propensity to Consume: The Marginal Propensity to Consume is defined as the proportion of the
aggregate raise inpay that isutilisedonthe consumptionof goodsandservicesopposingtothe amount being saved.
It can alsobe defined asInduced Consumption asthisshowsthe consumption of goods and services due to increase
in disposable incomes. The Marginal Propensity to Consume (MPC) is expressed mathematically as:
MPC = dC / dY
Where dC = Change in Consumption
dY = Change in Disposable Income
The Multiplier & the Marginal Propensity

In economics,the multipliereffectreferstothe idea that an initial spending rise can lead to an even greater
increase in national income. In other words, an initial change in aggregate demand can cause a further change in
aggregate output for the economy. The multiplier effect is a tool used by governments to restimulate aggregate
demand. The size of the multiplier depends on the marginal propensity to consume. The relation between
the Marginal Propensity and the Multiplier may be given as: Multiplier = 1 / (1 - MPC) = 1 / MPS
WithincreasingMPC(i.e. : decreasing MPS), the value of the multiplier increases as because themultiplier is
equal tothe reciprocal of the Marginal Propensity to Save. The greater the Marginal Propensity to Save, the smaller
will be the multiplier. The Greaterthe MarginalPropensity to Consume,the largerwouldbe the multiplier.Itgivesthe
idea that every rupee spend, creates more than one rupee in the economic activity.The effect of MPC on multiplier
can be understood with the help of the following diagram:
Section-C
Short Answer Questions. (Answer in about 100 words each) 2x6=12
7. Distinguish between any four of the followings:
i. Inferior goods and Giffen goods
Ans:An inferiorgoodisagood the demandforwhichdecreasesas income increases. Inferior goods have a negative
income elasticity of demand. The income effect is negative, but is outweighed by a positive substitution effect.
Therefore as prices increase, demand falls, and vice versa.
A Giffen good is a good where the income effect is so negative as to completely outweigh the substitution
effect.Aspricesincrease,demandincreases,andvice versa.ThismeansthatGiffengoodswouldhave apositive price
elasticityof demand.The mainideahere isthatGiffengoods are essential and have no close substitutes, so as their
price increases, disposable income is switched away from other goods and towards the Giffen good.
ii. Economic law and economic theory
Ans: Only four questions are required
iii. Multiplier and Accelerator

iv. Perfect Competition and Monopolistic Competition
v. External Economies and Internal Economies
Ans:Internal economiesof scale arise whenfirmsincreasetheirscale of production.Hence,theyincurlower average
costs of production, either through specialization or other factors. When average costs fall, giving the price of the
goodto be constant,profitmarginsof these firmswill be increased. Thus, the individual firm benefits from internal
economies of scale.
External economies of scale arise when all firms in an industry experience decreasing average costs of
production, which can be due to economies of concentration, information and disintegration. Unlike internal
economiesof scale,external economies of scales independent on the size of the individual firms in the industry as
both small and large firms benefit from it.
8. Explain any four of the followings:
i. Crowding-out Effect
Ans: Crowdingout isa situationwhere personalconsumptionof goodsandservicesandinvestmentsby business are
reducedbecause of increasesingovernment spending and deficit financing sucking up available financial resources
and raising interest rates. Crowding out creates some problems for economy. First, an expansionary fiscal policy
means that the government is using financial resources that are now longer available for use by individuals and
businesses.Additionally,if the governmentiscompetingforgoodsandservicesalongwithindividualsandbusiness,it
may result in increased prices because of the increase in demand.
ii. Real Cash Balances
iii. Investment Multiplier
iv. Economic Welfare

v. Personal Disposable Income
vi. Stagflation
vii. Positive Economics

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