Contact for all other solved assignments of MB0022 to MB0035 set 1

and 2 to firozkhan.gm@gmail.com

Name G M Firoz Khan

Roll No. 520931217
Program MBA
Managerial Economics
Subject
[Set 2]
Code MB 0026

Learning Systems Domain –Indira Nagar,

Centre Bangalore [2779]

Set 2 MB0026
1. What is pricing policy? What are the internal and external factors of
the policy?

A detailed study of the market structure gives us information about the way in
which prices are determined under different market conditions. However, in
reality, a firm adopts different policies and methods to fix the price of its
products. “Pricing Policy refers to the policy of setting the price of the
product or products and services by the management after taking into
account of various internal and external factors, forces and its own
business objectives”.

Pricing policy basically depends on the price theory that is the corner stone of
economic theory. Pricing is considered as one of the basis and central problems
of economic theory in a modern economy. Fixing prices are the most important
aspects of managerial decision making because market price charged by the
company affects the present and future production plans, pattern of
distribution, nature of marketing etc. Above all the sales revenue and the profit
ration of the producer directly depend on the prices. Hence, a firm has to
charge the most appropriate price, which is neither too high not too low, would
depend on a number of factors and focuses. There are no standard formulas or
equations in economics to fix the best possible price for a product. The dynamic
nature of the economy forces a firm to raise and reduce the prices
continuously. Hence prices fluctuate over a period of time.

Generally speaking, in economic theory, we take into account of only two

parties. i.e. Buyers and sellers while fixing the prices. However, in practice,
there are many parties associated with pricing of a product. They are rival
competitors, potential rivals, middlemen, wholesalers, retailers, commission
agents and above all the government. Hence we should give due consideration
to the influence exerted by these parties in the process of price determination.

The various factors and forces that affect the price are divided into two
categories. They are as follows:

a. External Factors(Outside factors):

i. Demand, supply and their determinants.

ii. Elasticity of demand and supply.
iii. Degree of competition in the market.
iv. Size of the market.
v. Good will, name, fame and reputation of a firm in the market.
vi. Trends in the market.
vii. Purchasing power of the buyers.
viii. Bargaining power of customers.
ix. Buyer behavior in respect of particular product.
x. Availability of substitutes and compliments.
xi. Government’s policy relating to various kinds of incentives,
disincentives, controls and restrictions.
xii. Regulations, licensing, taxation, export and import, foreign aid and
foreign capital.

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 xiii. Foreign technology, MNC’s etc.
xiv. Competitors pricing policy.
xv. Social consideration
xvi. Bargaining power of consumers.

b. Internal Factors(Inside Factors):

i. Objectives of the firm.

ii. Production costs.
iii. Quality of the product and its characteristics.
iv. Scale of production.
v. Efficient management of resources.
vi. Policy towards percentage of profits and dividend distribution.
vii. Advertising and sales promotion policies.
viii. Wage policy and sales turnover policy.
ix. Stage of the product on the product life cycle.
x. Use pattern of the product.
xi. Extent of the distinctiveness of the product.
xii. Extent of the product differentiation practices by the firm.
xiii. Composition of the product and life of the firm.

Thus, multiple factors and forces affect the pricing policy of a firm.

2. Mention three crucial objectives of price policies

Firms have multiple objectives today. In spite of several objectives, the

ultimate aim of every business is to maximise its profits. This is possible when
the returns exceed costs. In this context, setting an ideal price for a product
assumes greater importance. Pricing objectives has to be established by top
management to ensure not only that the company’s profitability is adequate but
also that the pricing is complementary to the strategy of organisation. While
formulating the pricing policy, a firm has to consider various economic, social,
political and other factors.
The following objectives are to be considered while fixing the prices of the
products.
a. Profit maximization in the short term:
The primary objective of the firm is to maximise its profits. Pricing policy as an
instrument to achieve this objective should be formulated in such a way as to
maximise the sales revenue and profit. Maximum Profit refers to the
highest possible profit. In the short run, a firm, not only should be able to
recover its total costs, but also should get excess revenue over costs. This will
build the morale of the firm and instil the spirit of confidence in its operations.
It may follow skimming price policy, i.e., charging a very high price when the
product is launched to cater the needs of a few sections of people. It may
exploit wide opportunities in the beginning. But it may provide fatal in the long
run. It may lose its customers and business in the market. Alternatively, it may
adopt penetration pricing policy. i.e., charging a relatively lower price in the
latter stages in the long run so as to attract more customers and capture the
market.

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b. Profit maximization in the long run:

The traditional profit maximisation hypothesis may not prove beneficial in the
long run. With the sole motive of profit maximisation a firm may resort to
several kinds of unethical practices like charging exorbitant prices, follow
Monopoly Trade Policy [MTP], Restrictive Trade Practices [RTP], Unfair Trade
Practices [UTP] etc. This may lead to opposition from the people. In order to
overcome these evils, a firm instead of profit maximisation, aims at profit
optimisation. Optimum Profit refers to the most ideal and desirable
profit. Hence, earning the most reasonable or optimum profit has become a
part and parcel of a sound pricing policy.

c. Price Stabilization:
Price stabilization over a period of time is another objective. The prices as far
as possible should not fluctuate too often. Price instability creates uncertain
atmosphere in the business circles. Sales plan becomes difficult under such
conditions. Hence, price stability is one of the important prerequisite conditions
for steady and persistent growth of a firm. A stable price policy only can win
the confidence of customers and may add good will of the concern. It builds up
the reputation and image of the firm.

3. Mention the bases of price discrimination.

Price discrimination refers to the practices of a seller to charge different prices

for different customers for the same commodity, produced under a single
control without corresponding difference in cost. When a monopoly firms adopts
this policy, it will become a discriminatory monopoly.
The following are the bases of price discrimination: to charge different prices
for different customers for the same commodity, produced under a single
control without corresponding difference in cost. When a monopoly firms adopts
this policy, it will become a discriminatory monopoly.
The following are the bases of price discrimination:
a. Personnel differences:
This is nothing but charging different prices for the same commodity
because of personnel differences arising out of ignorance and irrationality of
consumers, preferences, prejudices and needs.
b. Place:
Markets may divide on the basis of entry barriers, for eg. Price of goods will
be high in the place where taxes are imposed and low where there are no or
low taxes.
c. Different uses of the same commodity:
When a particular commodity or service is meant for different purposes
different rates may be charged depending upon the nature of the
consumption. For example, different rates may be charged for the
consumption of electricity for lightning, heating and production purposes in
industry and agriculture.
d. Time:
Special concessions or rebates may be given during festival seasons or

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 important occasions.
e. Distance:
Railway companies and other transporters, charge lower rates per kilometer
if the distance is long and higher rates if the distance is short.
f. Special orders:
When the goods are made to order it is easy to charge different rates to
different customers. In this case, particular consumer will not know the price
charged by the firm for other customers.
g. Nature of the product:
Prices charged also depend on the nature of the products. For example,
railways charge, higher for transporting coal, luxury items and less for
transporting, rice, wheat, and other life saving necessities.
h. Quantity of purchase:
When customers buy large quantities, discount will be allowed by the sellers.
When small quantities are purchased, discount may not be offered.
i. Geographical area:
Business enterprise may charge different prices at the national and
international markets. For example, dumping- charging lower pricein the
competitive foreign market and higher price in the secure home market.
j. Discrimination on the basis of income and wealth:
A doctor may charge higher fees for rich patients and lower fees for poor
patients.
k. Special classification of consumers:
Transportation authority such as railway and road ways; show concessions
to students and daily travelers. Different charges for I class and II class
travelling, ordinary coach, air conditioned coaches, special rooms and
ordinary rooms in hotels etc.
l. Age:
Cinema houses in rural areas and transport authorities charge different rates
for adults and children.
m. Preference of brands:
Certain goods will be sold under different brand names or trademarks in
order to attract customers. Different brands will be sold at different prices
even though there is not much difference in terms of costs.
n. Social or professional status of buyer:
A seller may charge more for those who occupy higher positions and have
higher social status; and less price for the common man on the street.
o. Convenience of the buyer:
If a customer is in hurry, higher price would be charged. Otherwise normal
price would be charged.
p. Discrimination on the basis of sex:
In selling certain goods producers ma discriminate between male and female
buyers by charging low price for females.
q. If price differences are minor, customer do not bother about such
discrimination.
r. Peak season and off peak season service:
Hotel and transport authorities charge different rates during peak season
and off peak seasons.

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4. What do you mean by fiscal policy? What are the instruments of
fiscal policy? Briefly comment on India’s fiscal policy.

Fiscal policy is an important part of the overall economic policy of a nation. It is

being increasingly used in modern times to achieve economic stability and
growth throughout the world. Lord Keynes for the first time emphasised the
significance of fiscal policy as an instrument of economic control. It exerts deep
impact on the level of economic activity of a nation.
Meaning:
The term ‘fisc’ in English language means treasury and as such, policy related
to treasury or government exchequer is known as fiscal policy. Fiscal policy is a
package of economic measures of the government regarding its public
expenditure, public revenue, public debt or public borrowings. It concerns itself
with the aggregate effects of government expenditure and taxation on income,
production and employment. In short it refers to the budgetary policy of the
government.

Instruments of fiscal policy:

Public Revenue:
It refers to the income or receipts of public authorities. It is classified into two
parts – Tax-revenue and non-tax revenue. Taxes are the main source of
revenue to a government. There are two types of taxes. They are direct taxes
like personal and corporate income tax, property tax and expenditure tax etc
and indirect taxes like customs duties, excise duties, sales tax now called VAT
etc. Administrative revenues are the bi-products of administrate functions of
the government. They include Fees, license fees, price of public goods and
services, fines, escheats, special assessment etc.
Public expenditure policy:
It refers to the expenditure incurred by the public authorities like central, state
and local governments. It is of two kinds, development or plan expenditure and
non-development or non-plan expenditure. Plan expenditure include income-
generating projects like development of basic industries, generation of
electricity, development of transport and communications, construction of dams
etc Non-plan expenditure include defence expenditure, subsidies, interest
payments and debt servicing changes etc.

Public debt or public borrowing policy:

All loans taken by the government constitutes public debt. It refers to the
borrowings made by the government to meet the ever-rising expenditure. It is
of two types, internal borrowings and external borrowings.

Deficit financing:
It is an extraordinary technique of financing the deficits in the budgets. It
implies printing of fresh and new currency notes by the government by running
down the cash balances with the central bank. The amount of new money
printed by the government depends on the absorption capacity of the economy.
Built in stabilizers or automatic stabilizers: [BIS]
The automatic or built in stabilizers imply automatic changes in tax collections
and transfer payments or public expenditure programmes so that it may reduce
destabilizing effect on aggregate effective demand. When income expands,

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automatic increase in taxes or reduction in transfer payments or government
expenditures will tend to moderate the rise in income. On the contrary, when
the income declines, tax falls automatically and transfers and government
expenditure will rise and thus built in stabilisers cushions the fall in income.

Fiscal tools:
Subsidies, development rebates, tax relief’s, tax concessions, tax exemptions,
and tax holidays, freight concessions, relief expenditures, debt relief’s, transfer
payments, public works programmes etc. are some of the main tools of the
fiscal policy.

Keynes insisted that public finance should be adjusted to the changing

conditions of the economy, to fight inflationary pressures and deflationary
tendencies. The role of fiscal policy can be compared to the driving of a car.
While driving up a gradient (i.e., stepping up production and productivity), what
is needed is an increase in power (promotion of higher savings and investment
through fiscal measures).On the other hand, when it moves against the
national interest, it is necessary to control the supply of power (to combat
inflationary and foreign exchange crisis through higher taxation) and also to
apply brakes judiciously to ensure that the vehicle does not slip out of control
but keeps on moving all the same. The national exchequer should see that the
brakes are not pressed so much as to bring the vehicle to a stop.

In short, it is the function of public finance to make economy grow; maintain it

in good health and to protect it from internal and external dangers.

Indian Fiscal Policy:

India faced a severe macroeconomic crisis in 1991. A series of economic

reforms, implemented in response, have, arguably, supported higher growth
and a more secure external payments situation. At times, structural reforms
seem to have stalled, and little progress has been made in areas such as labor
market and bankruptcy reforms. Perhaps the most striking aspect of reform is
the lack of progress in restoring fiscal balance. A high fiscal deficit of around
9.5% of GDP, widely perceived as unsustainable, contributed to the crisis of
1991.

India’s current fiscal situation is potentially grave, and could lead to an

economic crisis (fiscal, monetary and/or external) with severe short-term losses
of output and even political turmoil, or, alternatively and more subtly, many
years of continued underperformance of the economy. The prima facie solution
to the looming problem is obvious: control fiscal deficits. One complicating
factor is the existence of off-budget items that are not accurately measured or
monitored. The uncertainty associated with these items makes formulating
budgetary policies more challenging. Besides, fiscal policy obviously cannot be
analyzed in isolation. Monetary and exchange rate policies have to be
considered in conjunction with it. Beyond projecting aggregate outcomes of
(e.g., revenue, expenditure) India’s fiscal policy adjustment, there are issues of
distributional impacts and hence of politics.

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Table 1 summarizes the trends in Central and State fiscal deficits since 1990. It
shows that fiscal deficits began to rise in 1997-98 at both levels of government,
though the rise was much greater at the State government level.

Crisis resolution is almost always contentious as well as painful. For example,

crises in Argentina and Indonesia have had very high economic and social
costs. India, at least for the moment, does not appear to face an imminent
crisis, especially on the external front. Since crises very often arise from
adverse shifts in expectations or confidence than from deterioration in
fundamentals, this favorable situation could change rapidly if there is a
negative shock that affects confidence. Comparing the 2001-02 actual figures
with the Tenth Plan average targets (the first and
last rows in the below table) indicates that the goal is reduction of the Central
and State gross deficits by 1.2 and 1.3 percentage points respectively. The Plan
envisages substantial cuts in revenue deficits as the avenue for achieving the
required fiscal deficit reductions. The Center’s revenue deficit is supposed to be
reduced from 4.2% of GDP in 2001-02 to an average of 2.9% the Plan period,
while the corresponding figures for the States are 2.5%, and 1.3%
(Government of India, 2003, Table 2.22).

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Recently, various income transfer and social insurance schemes that reach into
rural areas and the informal sector of the economy have been announced.
While the objectives of such policies are laudable, they introduce yet additional
demands on the budget, which will be difficult to reverse, as they become
viewed as entitlements. Srinivasan (2002) and Rajaraman (2004) emphasize
that the Pay Commission award was not an exogenous shock, but one that was
predictable in the context of institutional and political economy considerations.
Thus, one can argue that pay, pensions and social insurance are all areas in
which there is virtually no uncertainty about their future costs so that the
government will have to do long term planning. While we have suggested that
the broad outlines of technical solutions to India’s short run fiscal problems are
well understood, leaving only the political difficulties of implementation, in the
case of long-term budgetary commitments, there seems to be a need for an
integrated analysis of the various possibilities. For example, the last Pay
Commission award was followed by increases in the pensions of those who had
already retired – while such ex post adjustments may again have laudable
motives, they represent a contingency that must be allowed for in projecting
the future liabilities of the government. The announcement in the interim
budget for 2004-05 of the merger of 50% of dearness allowance of civil
servants into their basic salary is not a good signal.
Even more broadly, India’s federal system needs to develop revenue
assignments and authorities that match expenditure responsibilities more
closely. This, in general, can be a positive step in controlling fiscal laxity. We
may note here that in addition to altering the pattern of existing assignments,
some long-run progress may also be made by redrawing the boundaries of the
larger States. In general, therefore, looking at the longer term and at broader
public welfare concerns can have three benefits. First, it allows for better inter
temporal planning of public expenditures within and across categories. Second,
it improves the pattern of near-term public expenditures toward spending that
reduces the chances of larger expenditures in the future. Third, it emphasizes
the need for a fiscal cushion or self-insurance to meet unavoidable expenditures
should they occur in the future.

India’s fiscal situation requires immediate attention: high growth and low
interest rates will not take care of the problem of long run sustainability of the
debt, nor the risks of a crisis in the short or medium run. However, high
reserves and a conservative monetary policy may not be sufficient insurance
against a crisis of confidence. There are theoretical reasons and previous
empirical evidence of high domestic debt and deficits being associated with
such a crisis. Furthermore, there are numerous potential sources of risk,
including interest rate volatility, as well as exogenous shocks.
One can simply state that there needs to be some short run fiscal adjustment,
otherwise the probability of a crisis or collapse may soon increase dramatically.
Furthermore, there are some obvious expenditure adjustments that can be
made, such as cutting or overhauling poorly designed subsidies, and at least
improving the efficiency of government expenditures. There are also some
steps that can be taken to enhance revenues while simultaneously cutting

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distortions in the tax system, including improving the efficiency of tax
collection.

5. Comment on the consequences of environmental

degradation on the economy of a community.
Rapid industrialization has become one of the main objectives in recent years.
Industrial development and economic development are used as synonymous
words today. Industrialization has brought several benefits to the man kind and
accelerated the process of economic development. At the same time, it has
posed several challenges to the entire world. Sustainable economic
development has become the major goal in many countries of the world. It
demands higher rates of economic growth with environmental preservation.
Environmental degradation in the process of rapid growth has become the main
concern in recent times. Global warming and damage to the ozone layer are the
talk of the day. There is great need for taking extra care to maintain ecological
balance in the entire world. A healthy globe can emerge only with a healthy
environment. Business has close relationships with natural environment and
business units have greater responsibilities in this direction. Maintenance of
reasonable ecological balance has become one of the pre-requisite conditions
for any business to flourish.

Environmental Degradation
In recent years, there has been very fast and quick economic growth in many
countries of the world. There is a visible change in the pattern of economic
growth. In the name of quick economic development in a very short period of
time, there is fast depletion of all kinds of resources and many types of
resources may be exhausted in the near future. There has been excessive and
over-utilization of many resources. Shortsightedness in the developmental
policies has shifted the emphasis from future to the present welfare of the
people. This has been responsible for environmental disorder, dislocation and
degradation. There is widespread air, water, soil and noise pollution on account
of rapid industrialization and growth in all modes of transportation. There is
environmental decay and degeneration all round the world. The destruction in
eco-system has dangerous and demoralizing effects on the economy.
Degradation and destruction of resource-base is unpardonable. They have
adverse effects on health, efficiency and quality of life of the people. Hence,
there is cry for environmental protection in recent years. Unless concrete
measures are taken in right time, the man kind may have to pay a heavy price
in the near future. In this background, today economists are talking about the
concept of sustainable economic development
Sustainable economic development seeks to meet the needs and aspirations of
the present without compromising the ability of future generations to meet
their own needs. It is felt that sustainable development can be achieved only
when the environment is protected, conserved, saved and improved consciously
by the people in a country. The process of development will become sustainable
only when the stock of various types of resources are maintained and further
improved. The various sources of resources, their quantities represent a
common heritage for all the generations. Hence, all out efforts are to be made

Set 2 MB0026
to augment these resources in several ways and means. There should be
proper balance between the present and future use of resources. There should
be proper balance between short-run and long run interests. Hence, it has been
suggested that there should be some form of environmental accounting system
in the development policy measures.
While estimating the national income of a country, under the new system of
accounting, one has to take in to account of the total physical volume of
resources and their monetary value. The total depreciation charges include the
wear and tear of capital assets, depletion of natural resources,, various kinds of
losses arising out of environmental decay and degradation etc. This will give us
a new measure of environmentally adjusted national output.
Environmental damages may be in the following categories. They are
as follows.
1. Water pollution
It is one of the most important types of pollution that is taking a heavy toll in
recent years. The main water pollutants are disease-causing agents which
include bacteria, viruses, protozoa and parasitic worms that enter water from
domestic sewage and untreated human and animal wastes, oxygen-depleting
wastes, inorganic plant nutrients, fertilizers, pesticides, water-soluble inorganic
chemicals which includes acids, salts, and compounds of toxic metals such as
mercury and lead, organic chemicals like oil, gasoline, plastic cleaning solvents,
detergents and many other varieties of items. As industrial wastes are dumped
in to the rivers and lakes, water is contaminated and it cannot be used for
drinking purposes. It creates health hazards. The capacity of the water to
preserve the aquatic life is becoming more and more difficult. Even
underground water is polluted today on account of various reasons and is
creating innumerable problems. Billions of people are affected by water
contamination in the world.
2. Air pollution
The air may become polluted by natural causes such as volcanoes, which
release ash, dust, sulphur, and other gases or by forest fires that are
occasionally naturally caused by lightening. But there are five primary
pollutants that together contribute to about 90% of the global air pollution.
These are- carbon monoxide, sulfur oxides, nitrogen oxides, hydrocarbons and
particular. Human sufferings increase due to the air pollution. Respiratory
disorders and cancers are due to inhalation of polluted air. The vehicles
increase the sulfur dioxide concentration in the air creating breathing problems
for children and affect their neurological developments.
3. Soil pollution
It arises as a result of excessive use of fertilizers, soil erosion, Salinization and
water logging, dumping of garbage and other kinds of unused wastes.
4. Deforestation
Forests protect environment in several ways. They provide a livelihood and
cultural integrity for forest dwellers and a habitat for a wealth of plants and
animals. They protect and enrich soils, provide natural regulation of the
hydrologic cycle, affect local and regional climate through evaporation,
influence watershed flows of surface and ground water, and help to stabilize the
global climate. Hence, they play a more useful role in preserving the ecological
and environmental balance and in maintaining the biodiversity and eco
systems. However, in recent years, there is terrific deforestation due to reckless

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industrialization and growth in urban areas which is responsible for several
problems.
5. Loss of biodiversity
Biological diversity, a composite of genetic information, species and eco
systems, all provide material wealth in the form of food, medicine and inputs to
industrial processes. It supplies the raw material that may assist human
communities to adapt to future and unforeseen environmental stresses.
Furthermore, many people value sharing the earth with numerous other forms
of life and want to bequeath this heritage to future generations. Loss of
biodiversity jeopardizes all this benefits.
6. Solid and hazardous wastes
Excessive quantities of solid wastes generation, inadequate collection and
unmanaged disposal etc present serious problems for human health and
productivity. Open dumping and uncontrolled land filling causes several types of
diseases and contributes for the spread of diseases. Solid and hazardous
wastes pollute ground water resources.
Thus, several factors have contributed for environmental degradation.
Business And Natural Environment
Business and environment are very closely related to each other. The nature,
magnitude, composition and direction of business basically depends upon the
type of natural environment exists in a country. Business and environment has
symbiotic relationship with each other. They are inseparable in nature. Natural
environment includes land form, location aspects, topographical conditions,
mountains, rivers, oceans, coast lines, forests, soil, weather and climatic
conditions, natural endowments, flora and fauna etc. Natural environment is
also called as physical environment. Ecological factors which include both
renewable and non-renewable resources would affect the type of economic and
business activities in a country. Geographical factors would decide the type of
goods and services that may be produced most economically in a county.
Natural hazards like floods, droughts, earth quakes, storms, heat and cold
waves and volcanic eruptions would decide the nature of business. Thus, all
business activities are guided and influenced by natural environment either
directly or indirectly. Nature is a great storehouse of all kinds of materials which
are to be used by a business unit in the most economical and profitable
manner.
Apart from it, the natural environment also provides certain physical and
biological conditions within which man lives, works and carry on his business.
How best business units exploit and use these resources to maximize their
profits and maximize social benefits is the question before any economy.
Business units have to come out with such business plans which results in
proper, better and full utilization of all kinds of resources in the most optimum
manner leading to higher output, income and employment in the country with
minimum costs. It is to be remembered that business activities should not
create environmental pollution and degradation at any cost. This calls for
greater social responsibilities on them. They have to realize that only good
environment can bring good business. Social costs are to be considered while
making private profits and private profits should not come in the way of social
benefits and welfare. Hence, proper balancing is required between the two. If
social costs exceed private profits, in that case, government interference will

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become inevitable and it will be justified in the overall interest of the entire
society.
Environmental Degradation And Market Failure
While taking any decision, one has to weigh the impact of each one of them on
another. In a competitive market oriented economy, everything is left to the
free and automatic market mechanism.

Internalizing externality occurs when an individual business unit takes external

cost or benefits in to account. In case there are external benefits, they can be
internalized or external costs may be borne by the business unit itself.
However, a firm has to make cost-benefit analysis in its business operations
both at the micro level and macro level. Externalities will not always result in
inefficiency as a firm compares the benefits also. Some sort of government
intervention is necessary to overcome the market failures associated with
pollution and other externalities. The government may take several measures
to solve the problems arising out of negative externalities. The following
measures deserve our attention in this direction.
1. Government taxes and subsidies
a. If MSC > MPC of an activity, the government has to tax on producers.
b. If MSC < MPC of an activity, the government has to subsidize producers.
c. If MSB < MPB of an activity, the government has to tax on consumers.
d. If MSB > MPB of an activity, the government has to subsidize consumers.
Again, if the government wants to control pollution, in that case, it will collect
pollution cost in the form of imposing taxes on business units. But it is to be
noted that the entire pollution cost cannot be compensated by the firm.
Industrial growth inevitably leads to the creation of negative externalities and
the society has to bear a part of the cost unavoidably. Hence, total elimination
of industrial pollution is not possible and industrial units cannot pay in the form
of taxes to compensate the adverse effects of pollution. The tax amount is to be
compared with loss to consumers and reduction in the quantity of output by the
firms.
2. Direct government regulations
In case of all kinds of pollution and other health and security externalities, the
government may introduce direct regulatory controls [social regulations] over
the externality by setting certain rules and regulations regarding pollution,
which every industry should follow. Under the command and control
regulations, the government would simply order the firm to comply, giving
detailed instructions on what pollution-control technology to use and where to
apply etc. For example, installation of pollution control equipment in factories
and disposing the chemical and industrial wastes in a specific way is directly
regulated by the government.
3. Introduction of emission standards
An emission standard is a legal limit on how much pollution a firm can emit. If
the firm exceeds the limit, it can face monetary and even criminal penalties.
The standard prescribed by the government ensures that the firm produces
efficiently. The firm meets the standard by installing pollution abatement or
reducing equipment. The cost incurred by the firm to install the new equipment
is included in its final market price and thus it internalizes the externalities.
4. Prescribing emission fees

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An emission fee is a charge levied on each unit of a firm’s emissions. Such
emission fees would require that firms pay a tax on their pollution equal to the
amount of external damage it causes. If a firm is imposing external marginal
costs of Rs. 200-00 per ton on the surroundings, in that case, the appropriate
emissions charge would be Rs. 200-00 per ton. This is another way of
internalizing the externality by making the firm to include the social costs of its
activities in total cost of production.
5. Introduction of transferable emissions permits
Under this system, each firm must have a permit to generate emissions. Each
permit specifies exactly how much the firm is allowed to emit. Any firm that
generates emissions that are not allowed by permit is subject to substantial
monetary sanctions. Permits are allocated among firms, with the number of
permits chosen to achieve the desired maximum level of emissions. The
permits are marketable-they can be bought and sold.
6. Introduction of Liability rules
Instead of direct government regulations, a government may come out with the
introduction of liability rules or laws. Under this approach, the legal system
makes the generators of externalities legally liable for any damages caused to
other persons. In effect, by imposing an appropriate liability system, the
externality is internalized.
7. Defining property rights
Defining individual property rights to some extent solve the problem of
externalities. Property rights are the legal rules that describe what people or
firms may do with their property. When people have property rights to land for
example, they may build on it or sell it or protect it from interference by others.
A factory constructed near a lake starts throwing wastes and toxic chemicals in
the river. This leads to water pollution as people have an attitude that lake is
nobody’s property and convenient to dump the wastes and garbage. Cleaning of
such a polluted lake either by a private institution or the government involves a
free-rider problem if no one owns the lake. The benefits of a clean lake are
enjoyed by many people and no one can be charged for these benefits.
However, if the same lake is owned by a person or institution, they can charge
higher prices to fishermen, boaters, recreation users and others who benefit
from the lake
Global environmental threats
Rapid industrialization, urbanization and economic growth have created
innumerable global environmental problems in recent years. They have posed
severe threats to the very survival of the mankind. Some of the important
threats are as follows- change in climate, global warming, acid rain, ozone layer
depletion, nuclear accidents and holocaust etc. Let us study them in some
detail.
1. Climate change
Climate is the average weather conditions of a place for a fairly long period of
time covering a number of years. Climate change is a shift in the average
weather that a given region experiences. This is measured by changes in all the
features one can associate with weather, such as temperature, wind patterns,
precipitation and storms etc. Global climate change implies changes that occur
in global climatic conditions. Climate change is a normal process.

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It may reduce the availability of clean drinking water, contaminate water,
damage sewage systems, spread infectious diseases, increase in pests and
plant animal diseases, reduce food production, create starvation and
malnutrition etc. Food and water shortages may lead to conflicts leading to
displacement of a large number of people. Changes in climate may also affect
the distribution of vector species like mosquitoes which in turn will increase the
spread of diseases like malaria and filariasis and spread to new areas. Thus,
climatic change may have serious impacts on human health. It may also
increase various current health problems and also bring new and unexpected
ones.
2. Global warming or green house effect.
Global warming means an increase in the average temperature of the
atmosphere, oceans, and landmasses of Earth. The average temperature has
been increasing in many regions in recent decades. The average temperature of
Earth is about 15 oC. Over the last century, this average has risen by about 0.6
Celsius degrees. Scientists are of the opinion that it may increase to 1.4 to 5.8
Celsius degrees by the year 2100. This warming will be greatest over land
areas and at high latitudes. The main causes for global warming are as follows-
burning of fossil fuels such as coal, oil, gas which releases into the atmosphere
carbon dioxide and other substances known as greenhouse gases. As the
atmosphere becomes richer in these gases, it becomes a better insulator,
retaining more of the heat provided to the planet by the sun.
The word Green House Effect was first coined by J. Fourier in the year 1827.
Greenhouse is constructed for plants mainly in the cold countries where total
insolation at least during winter season is not sufficient enough to support plant
growth. The glasses of greenhouses are such that they allow the visible sunlight
to enter but prevent the long wave infra red rays to go out. The greenhouse
effect on earth means progressive warming-up of the earth’s surface due to the
blanketting effect of man-made carbon dioxide in the atmosphere. In short, the
trapping of heat from the sun by certain pollutant gases like carbon dioxide,
chlorofluoro carbons, nitrous oxide, methane etc in the atmosphere, leading to
rise in the earth’s mean temperature, is known as greenhouse effect. Carbon-
dioxide is a natural constituent of the atmosphere but its concentration is
increasing in that air at an alarming rate. It is released by combustion of fossil
fuels. About half of the CO2 emitted stays in the atmosphere and the other half
of it is removed by the oceans and the plants. When there is an increase in
greenhouse gases, it causes warming up of the earth. The greenhouse effect is
also known as global warming.

Adverse effects of global warming

1. It causes climatic changes. Extreme weather conditions like floods and
droughts are likely to occur more frequently.
2. It results in melting of ice and glaciers leading to rise in sea levels and
flooding of coastal areas.
3. Small islands may even disappear due to submergence.
4. It leads to a change in crop pattern.
5. It creates adverse effects on eco systems biodiversity.
6. It results in changes in hydrological cycle and storms will be more
frequent and intense.
3. Acid rain

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The term acid rain was first coined by Robert Angus in 1872. When fossil fuels
such as coal, oil and natural gas are burned, chemicals like sulfur dioxide and
nitrogen oxides are produced. These chemicals react with water and other
chemicals in the air to form sulfuric acid, nitric acid, and other harmful
pollutants like sulfates and nitrates. These acid pollutants spread upwards into
the atmosphere, and are carried by air currents, to finally return to the ground
in the form of acid rain, fog or snow. The corrosive nature of acid rain causes
many forms of environmental damage. Acid pollutants also occur as dry
particles and gases, which when washed from the ground by rain, add to the
acids in the rain to form an even more corrosive solution. This is called as acid
deposition.

Adverse effects of acid rain

1. Have ill-effects on vegetation.
2. Have ill-effects on soils and crop productivity.
3. Have effects on monuments statues and buildings.
4. Have adverse effects due to acidification of lakes and streams and
acquatic life

4. Ozone layer depletion

Ozone is formed by the action of sunlight on oxygen. Ozone in the upper
atmosphere however, is vital to all forms of life as it protects the earth from the
sun’s harmful UV radiation. Ozone layer is a thin band in the ozonosphere which
blocks out sun’s ultra violet rays [ie, screens out sun's harmful ultra radiation]
and protects life on earth from the harmful ultraviolet radiation from the sun.
In the ozonosphere, small amounts of ozone are constantly being formed by
the action of sunlight or oxygen. At the same time, ozone is being broken down
by natural processes. Normally, the total amount of ozone usually stays
constant, because its formation and destruction occur at about the same rate.
But unfortunately, human activities have recently changed the natural balance.
Some manufactured substances, such as chlorofluoro carbons,
hydrochlorofluoro and hydrochloric carbons, which are used in refrigerators, air
conditioners, solvents, hospital sterilizations etc, enter ozonosphere and
destroy ozone much faster than it is formed. The result is ozone depletion.

Adverse effects of ozone depletion

1. More ultra violet radiations are harmful to the life system on the earth
and natural vegetation.
2. Create adverse effects of productivity and crop yield
3. Create adverse effects on animal life and cause damage to wild life and
marine life.
4. Create adverse effects on human health. It is responsible for sunburn,
skin cancer, blindness etc.

5. Nuclear accidents and holocaust.

Nuclear accidents refer to accidents resulting from nuclear devices and radio-
active materials. It also includes accidents resulting from the release of
radioactive contamination. One can recollect a few nuclear accidents in some
parts of the world.

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The Chernobyl disaster is the most serious one. This accident occurred ion 26th
April, 1986 at the Chernobyl reactor near Kiev, the capital of Ukraine. This
accident occurred 3whenan explosion and fire took place at the nuclear reactor.
The core fires allowed a continuous release of activity which was slowly
reduced. Again a second release of activity occurred on 5th may 1986. Nearly
31 people were killed, 200 people were diagnosed as suffering from acute
radiation effect. About 1 35,000 people and a large number of animals were
evacuated from a 30Km radius surrounding the plant

Nuclear holocaust refers to whole sale destruction caused by fully burnt nuclear
weapons or bombs.
The best examples of nuclear holocausts are the dropping of atom bombs by
American army on Hiroshima and Nagasaki cities in Japan during the II world
war. On 6th august 1845, the nuclear bomb was dropped on the city of
Hiroshima and on 9th August 1945, another bomb was dropped over the
industrial city of Nagasaki. It was estimated that as many as 1,40,000 people
died in Hiroshima and about 74,000 people died in Nagasaki on account of the
dropping of the bombs. The incidence is in the green memory of the entire
world.
Another serious threat is emerging in many countries on account of using
mobile phones while driving the vehicles. It has created problems not only for
the person who drive the vehicle but also for other people who drive their
vehicles on the roads and pedestrians.
Yet another major threat is from international terrorism which has taken a
heavy toll in the entire world.

6. Write a note on
Stagflation
Philip Curve

Stagflation

The present day inflation is the best explanation for stagflation in the whole
world. It is inflation accompanied by stagnation on the development front in an
economy. Instead of leading to full employment, inflation has resulted in un-
employment in most of the countries of the world. It is a global phenomenon
today. Both developed and developing countries are not free from its clutches.
Stagflation is a portmanteau term in macro economics used to describe
a period with a high rate of inflation combined with unemployment and
economic recession. Inflationary gap occurs when aggregate demand
exceeds the available supply and deflationary gap occurs when aggregate
demand is less than the aggregate supply. These are two opposite situations.
For instance, when inflation goes unchecked for some time, and prices reach
very high level, aggregate demand contracts and a slump follows. Private
investment is discouraged. Inflationary and deflationary pressures exist
simultaneously. The existence of an economic recession at the height of
inflation is called ’stagflation’.

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The effects of rising inflation and unemployment are especially hard to
counteract for the government and the central bank. If monetary and fiscal
measures are adopted to redress one problem, the other gets aggravated. Say,
if a cheap money policy and public works program are adopted to remedy
unemployment inflation gets aggravated. On the other hand, if a dear money
policy and stringent fiscal measures are followed unemployment will get
aggravated. It is the most difficult type of inflation that the world is facing
today. Keynesian remedial measures have not succeeded in containing inflation
but actually have aggravated un-employment. Thus, the world stands today
between the devil (inflation) and deep sea (unemployment).

Phillips Curve
A.W.Phillips the British economist was the first to identify the inverse
relationship between the rate of unemployment and the rate of increase in
money wages. Phillips in his empirical study found that when unemployment
was high, the rate of increase in money wage rates was low; and when
unemployment was low, the rate of increase in money wage rates was high.
Phillips calls it as the trade-off between unemployment and money wages. This
is illustrated in the figure below.

In the figure the horizontal axis represents the rate of unemployment and the
vertical axis represents the rate of money wages. In the figure PC represents
the Phillips curve; PC is sloping downwards and is convex to the origin of the
two axes and cuts the horizontal axis. The convexity of PC shows that money
wages fall with increase in the rate of unemployment or conversely money
wages rise with decrease in the rate of unemployment.
This inverse relationship between money wage rates and unemployment is
based on the nature of business activity. During the period of rising business
activity wage rate is high and the rate of unemployment is low and during
periods of declining business activity wage rate is low and the rate of
unemployment is high.
Paul Samuelson and Robert Solow extended the Phillips curve analysis to the
relationship between the rate of change in prices and the rate of unemployment
and concluded that there is a trade-off between the level of unemployment in a
country and the rate of inflation.

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We can use the same figure to illustrate this concept, instead of money wages
we show rise in the price level on the OY axis. It will be clear from the above
figure, that the higher the rate of inflation, the lower is the rate of
unemployment in the country; and lower the rate of inflation, the higher the
rate of unemployment in the country i.e., one can be achieved at the cost of
the other. Phillips curve analysis can be a guide to the government in striking a
balance between the measures to be adopted to solve the problem of
unemployment and inflation.

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