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Bachelors Degree
Programme
(BDP)

ASSIGNM
ENT
(201314)

Course Code: EEC11

FUNDAMENTALS OF
ECONMICS

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School of Social
Sciences
Indira Gandhi National Open
University
Maidan Garhi, New Delhi110 068

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EEC-11
FUNDAMENTALS OF ECONMICS
Assignment (TMA)
2013-14
Programme Code: BDP
Course Code: EEC-11

Dear Student,
As explained in the Programme Guide for BDP, you will have to do one assignment
for this Elective course in Economics (EEC-11). This is a Tutor Marked Assignment
(TMA) and carries 100 marks.
It is important that you write answers to all the questions in your own words. The
TMA is designed to enable you to answer different categories of questions. Here
evaluation is made keeping in view your ability to present your answer in a
systematic, precise and coherent manner. The assignment is divided into three
Sections. Remember that all questions are compulsory. Section A comprises two
long answer questions of 20 marks each. Section B comprises four questions of 12
marks each while in Section C you have to answer two questions of 6 marks each.
Submission: The completed assignments should be submitted to the Coordinator
of your Study Centre on or before

--------------------------------------------

March 31, 2014 for July 2013 session and 30th September, 2014 for January 2014
session.

Contact For Project Work-8882309876 or www.solvezone.in

EEC-11
FUNDAMENTALS OF ECONOMICS
TMA
(Coverage:
Blocks 1 to
10)
Programm
e Code:
BDP
Course Code: EEC-11
Asst. Code: EEC-11/AST/TMA/2013-14
Maximum
Marks:
100
Note: Answer all the questions.

2
SECTION A. Long Answer Questions. (Answer in about 500
words each)

40

1. Distinguish between Cardinal utility approach and Ordinal utility approach to

consumer behavior. Explain the consumers equilibrium in terms Marshallian Law
of equi-marginal utility. Give illustrations in support of your answer.
ANSCardinal and ordinal approaches both are related to the UTILITY of a commodity. As you
know utility is the want satisfying capacity or ability of a commodity... Now acc. To the
cardinal approach utilities of 2 commodities can be measured as well as compared (in
terms of number of units of a commodity purchased)... On the other hand the ordinal
approach says it is not possible to measure utility of a commodity. If we think logically
utility is totally a subjective experience. Some commodity which might have utility for
you might not have for me or may be the degree or extent of utility might be different for
2 people. Thus logically it is not possible to measure utility in exact terms. Therefore the
ordinal approach is considered to be better than the cardinal approach as it is more
realistic and practical.
The main assumptions of the law of equi-marginal utility are as under.
(1) Independent utilities. The marginal utilities of different commodities are
independent of each other and diminishes with more and more purchases.

20=

(2) Constant marginal utility of money. The marginal utility of money remains constant
to the consumer as he spends more and more of it on the purchases of goods.
(3) Utility is cardinally measurable.
(4) Every consumer is rational in the purchase of goods.
(5) Limited money income. A consumer has limited amount of money income to
spend.
Consumers equilibrium with two or more than two goods purchased. A prudent
consumer in order to get the maximum satisfaction from his limited means compares not
only the utility of a particular commodity and the price but also the utility of the other
commodities which he can buy with his scarce resources. If he finds that a particular
expenditure in one use is yielding less utility than that of other, he will try to transfer a
unit of expenditure from the commodity yielding less marginal utility to commodity
yielding higher marginal utility. The consumer will reach his equilibrium position when it
will not be possible for him to increase the total utility by transferring, expenditure from
less advantageous uses to more advantageous uses.
The consumer will maximize total utility from his given income when the utility
from MuaMub the last rupee spent on each good is the same. Algebraically, this is
when, pa = p =MU
pn__. Here (a), (b), (c).n are large number goods consumed.
Pc
It may here be noted that when a consumer is in equilibrium there is no way to increase
utility by reallocating his given money income.
The doctrine of equi-marginal utility can be explained by taking an example. Suppose a
person has Rs. 5 with him which he wishes to spend on two commodities, tea and
cigarettes. The marginal utility derived from both these commodities is as under:
Units of Money

MU of Tea

MU of Cigarettes

1.

10

2.

3.

12
10
A

4.

5.

Rs.5

Total

Total

Utility =30

Utility =39

A rational consumer would like to get maximum satisfaction from Rs. 5.00. He can spend
this money in three ways.
(1) Rs. 5.00 may be spent on tea only.
(2) Rs. 5.00 may be utilized for the purchase of cigarettes only.
(3) Some rupees may be spent on the purchase of tea and some on the purchase of
cigarettes.
If the prudent consumer spends Rs. 5.00 on the purchase of tea, he gets 30 utility. If he
spends Rs. 5.00 on the purchase of cigarettes, the total utility derived is 39 which is higher
than tea. In order to make the best of the limited resources, he adjusts expenditure.
(1) By spending Rs. 4.00 on tea and Rs. 1.00 on cigarettes, he gets 40 Utility
(10+8+6+4+12=40).
(2) By .spending Rs... 3.00 on tea and Rs. 2.00 on cigarettes, he derives 46 Utility
(10+8+6+12+10=46).
(3) By spending Rs. 2.00 on tea and Rs. 3.00 on cigarettes, he gets 48 utility
(10+8+12+10+8=48).
(4) By spending Rs. 1.00 on tea and Rs. 4.00 on cigarettes, he gets 46 utility
(10+12+10+8+6=46).
The sensible consumer will spend Rs. 2.00 on tea and Rs. 3.00 on cigarettes and will get
the maximum satisfaction. When he spends Rs. 2.00 on tea and Rs. 3.00 on cigarettes, the
marginal utility derived from both these commodities is equal to 8. When the marginal
utilities of the two commodities are equalized, the total utility is then maximum, i.e., 48 as
is clear from the schedule given above. The law of equi-marginal utility can be explained
with the help the diagrams.

2. Critically examine the various theories of demand for money.

AnsIn economics, the money supply or money stock, is the total amount of assets available
in an economy at a specific time. There are several ways to define "money," but standard
measures usually include currency in circulation and demand deposits (depositors' easily
accessed assets on the books of financial institutions).
Traditionally legal tender was created by the issuer striking coins or issuing banknotes in
exchange for goods and services. Inside money, and fractional reserve
banking allows financial institutions to lend money without the lender having first to
obtain a similar income from savings or sales
Money supply data are recorded and published, usually by the government or the central
bank of the country. Public and private sector analysts have long monitored changes in
money supply because of its effects on the price level, inflation, the exchange rate and
the business cycle.

That relation between money and prices is historically associated with the quantity theory
of money. There is strong empirical evidence of a direct relation between money-supply
growth and long-term price inflation, at least for rapid increases in the amount of money
in the economy. That is, a country such as Zimbabwe which saw rapid increases in its
money supply also saw rapid increases in prices (hyperinflation). This is one reason for
the reliance on monetary policy as a means of controlling inflation.
The Theory of Money Demand is considered the brain-child of the famous Polish
astronomer and mathematician, Copernicus. In the hands of the Jean Bodin, the noted
economist, the theory progressed immensely in establishing the relation between gold and
silver imports and rise in the market prices. In the Quantity Theory of Money, the
Equation of Exchange which substantiates the relation between the supply of money and
the value of cash transaction was first affirmed by David Hume, the well-known
philosopher and later expanded by the renowned British political economist, John Stuart
Mill. Between 19th and 20th century, other prominent economists like Irving Fisher,
Simon Newcomb and Alfred de Foville further developed the theory, offering it the
present form. There are basically three theories to the demand for money. They are the
Classical, Keynesian and the Quantity Theory of Money. Each of them may be discussed
under the following heads:
Classical theory of money demand:
The main concern of this theory is to analyse how money may affect the Aggregate
Demand (AD) of goods and services in the economy. According to the Classical Theory
the AD is more or less stable. Shifts in the demand and the supply of money cause changes
in the AD and the general price level. This theory does not explain the different
components of AD.
Keynesian Theory of Money Demand:
As opposed to the classical theory the Keynesian theory decomposes money demand into
Consumption, investment, Government spending and trade balance.
Mathematically,
AD = C+I+G+(X-M) where C = Consumption of currently produced goods and services
I = Investment
G = Government Spending in the currently produced goods and services
X = Export
I = Import
According to the Keynesian Theory of the demand for money, the Aggregate demand is
highly unstable due to changes in business and consumer expectations. Money does not
play a vital role in the determination of the general price level and the Aggregate Demand
of the economy.
Quantity Theory of Money
The Quantity Theory of Money can be explained by the equation:
Ms V = PY
Or Ms = (Y/V) *P

Where Ms: Supply of Money

Y: Income Level
V: Velocity of Money
P: Price Level
This equation implies that keeping the velocity of money and the income level constant,
changes in the supply of money would cause changes in the general price level.

SECTION B. Medium Answer Questions. (Answer in about 250 words

each)

412=48

3. How wages are determined in the perfectly competitive market? Why do so many
kinds of wage Rates prevail in the market?
AnsHow wages are determined in a perfectly competitive labour market. A perfectly
competitive labour market will have the following features

Many firms

Perfect information about wages and job conditions

Firms are offering identical jobs

Many workers with same skills

Diagram of Wage Determination

The equilibrium wage rate in the industry is set by the meeting point of the

industry supply and industry demand curves.

In a competitive market firms are wage takers because if they set lower wages

workers would not accept the wage.

Therefore they have to set the equilibrium wage we.
Because firms are wages takers the supply curve of labor is perfectly elastic

therefore AC = MC
The firm will maximize profits by employing at Q1 where MRP of Labor = MC of
Labor

Most Americans have probably never heard of prevailing wage laws, or if they have,
have a vague sense that they are harmless and dont have anything to do with them.
Nothing could be further from the truth. Prevailing wage laws ought to be of immediate
concern to all Americans because they have a direct impact on their quality of life and the
taxes they pay.
Most prevailing wage laws apply to government contracts for construction. The best
known is the federal Davis-Bacon Act. About half the states have similar little DavisBacon laws. There is also a federal prevailing wage law for service contracts.
These depression era laws require that workers on government contracts be paid wages
supposedly prevailing in the community where the work is being done. The stated
reason for prevailing wage laws was to prevent government contractors from undermining
local wage rates by importing workers from low wage areas.
4. What is the distinction between money flow and real flows? Explain how various
economic transactions are used to study circular flow of income.
Ans-

1. Real flow is the exchange of goods and services between household and firms
whereas money flow is the monetary exchange between two sectors.
2. In real flow household sector supplies raw material, land, labour, capital and
enterprise to firms and in return firms sector provides finished goods and services
to household sector. Whereas in money flow, firm sector gives remuneration in the
form of money to household sector a wages and salaries, rent, interest etc.
3. Difficulties of barter system for the exchange of goods and factor services between
households and firms sector in real flow, whereas no such difficulty or
inconvenience arise in money flow.
4. When goods and services flow from one sector of the economy to another, it is
known as real flow.
The Circular Flow of income
National income, output, and expenditure are generated by the activities of the two most
vital parts of an economy, its households and firms, as they engage in mutually beneficial
exchange.
Households
The primary economic function of households is to supply domestic firms with needed
factors of production - land, human capital, real capital and enterprise. The factors are
supplied by factor owners in return for a reward. Land is supplied by landowners, human
capital by labor, real capital by capital owners (capitalists) and enterprise is provided by
entrepreneurs. Entrepreneurs combine the other three factors, and bear the risks associated
with production.
Firms
The function of firms is to supply private goods and services to domestic households and
firms, and to households and firms abroad. To do this they use factors and pay for their
services.
Factor incomes
Factors of production earn an income which contributes to national income. Land receives
rent, human capital receives a wage, real capital receives a rate of return, and enterprise
receives a profit.
Members of households pay for goods and services they consume with the income they
receive from selling their factor in the relevant market.
Production function
The simple production function states that output (Q) is a function (f) of: (is determined
by) the factor inputs, land (L), labor (La), and capital (K), i.e.
Q = f (L, La, K)

5. With the help of Is-Lm technique, explain the process of integrations of money
market and goods market by way of Keynesian approach. What are the policy
implications of Keynesian approach?
AnsIn this particular aspect of macroeconomics we will discuss about the theory of product
market equilibrium and with the theory of money market equilibrium and interest rate
determination. Keynes had analysed the product market and money market equilibrium in
isolation of one another. This is considered to be a serious flaw in the Keynesian approach
because, in reality, functioning of both the sectors is interrelated and interdependent.
Therefore, unless both the markets reach equilibrium simultaneously at the same rate of
interest and the same level of income, none of these sectors can attain a stable equilibrium.
It was John R. Hicks who integrated the Keynesian analysis of the product and money
markets and developed a model, called IS-LM Model, to show how both the markets can
attain equilibrium simultaneously at the same interest rate and national income. The postKeynesian developments in macroeconomics do not end with Hicks IS-LM Model. The
economists of later generations have also constructed theories that integrate classical and
Keynesian economics, and have developed different kinds of aggregate demand and
supply models. This was followed by other developments with altogether new approach to
deal with macroeconomic issues. This part of the book presents a detailed discussion on
the Hicksian IS-LM model and a brief discussion on the other post Keynesian
developments in macroeconomics.
Keynesian economics, also called Keynesianism, is an economic theory based on the ideas
of an English economics, John Maynard Keynes t, as put forward in his book The General
Theory of Employment, Interest and Money, published in 1936 in response to the Great
Depression of the 1930s. Keynesian economics promotes a mixed economy, where both
the state and the private sector play an important role. The rise of Keynesianism marked
the end of laissez-faire economics (economic theory based on the belief that markets and
the private sector could operate well on their own, without state intervention).
6. What do you understand by the term externalities? Explain the various methods
to deal with externalities.
AnsIn economics, an externality is the cost or benefit that affects a party who did not choose
to incur that cost or benefit.
For example, manufacturing activities that cause air pollution impose health and clean-up
costs on the whole society, whereas the neighbors of an individual who chooses to fireproof his home may benefit from a reduced risk of a fire spreading to their own houses. If
external costs exist, such as pollution, the producer may choose to produce more of the
product than would be produced if the producer were required to pay all associated
environmental costs. If there are external benefits, such as in public safety, less of the
good may be produced than would be the case if the producer were to receive payment for
the external benefits to others. For the purpose of these statements, overall cost and benefit
to society is defined as the sum of the imputed monetary value of benefits and costs to all

parties involved. Thus, it is said that, for goods with externalities, unregulated market
prices do not reflect the full social or benefit of the transaction.
As mentioned above, there are three general ways we can proceed:
1) Command and Control. This is exactly what it sounds like: governments issue
commands in order to control the amount of pollution. If emitters fail to comply with these
rules, they face criminal sanction and the possibility of fines and imprisonment.
2) Coasian permit trading. This is a system whereby the government delegates to itself the
property right to emitting sulfur dioxide and then sells (or gives away) these property
rights. A company needs a permit for every ton of SO2 they wish to emit into the
environment, and the quantity of those permits is controlled by the government. This
method has the benefit of allowing firms to trade permits so that firms that have a high
cost of emitting can buy rights from firms that can reduce pollution at lower costs, which
means that as a society we can have the same amount of pollution reduction as in the
command and control method, but at a lower cost to society. This will be illustrated a little
later. This method is called "cap and trade" because the government will set a cap on the
amount of SO2 that can be emitted each year and then allow emitters to trade amongst
themselves to obtain the socially efficient result.
3) Pigouvian taxes. These are taxes on pollutants, and got their name from the first person
to propose them, a British economist called Arthur Pigou. This method contrasts with cap
and trade in this way: with a Coasian system, we are setting the socially optimal quantity,
and then allowing the price to find the market equilibrium. In theory, this is equivalent to
the "social cost", the difference between the two supply curves in our social versus private
equilibrium diagram. The good thing is, we do not have to try to figure out this cost,
which can be extremely difficult to discover, but instead, we can simply let the market
find the level. A Pigouvian tax moves the equilibrium from the private to the social one,
but it does so by setting a fixed cost (the tax), and then allowing quantity to adjust in the
marketplace. The problem with this system is that it requires more information. If the tax
is too high, the quantity emitted will move to a quantity below the socially optimal value,
which means that some wealth is destroyed. If the tax is too low, then we will not reduce
pollution by very much, and will be producing at a level above the socially optimal
amount, which is also not a wealth maximizing situation.

SECTION C. Short Answer Questions. (Answer in about 100 words

each)

26=12

7. Explain the followings:

i) Production Possibilities Curve
AnsIn economics, a productionpossibility frontier (PPF), sometimes called a production
possibility curve, production-possibility boundary or product transformation curve, is a

graph that shows the various combinations of amounts of two commodities that could be
produced using the same fixed total amount of each of the factors of production.
Graphically bounding the production set for fixed input quantities, the PPF curve shows
the maximum possible production level of one commodity for any given production level
of the other, given the existing state of technology. By doing so, it defines productive
efficiency in the context of that production set: a point on the frontier indicates efficient
use of the available inputs, while a point beneath the curve indicates inefficiency. A period
of time is specified as well as the production technologies and amounts of inputs
available. The commodities compared can either be goods or services.

ii) Economic theory

AnsEconomic Theory provides an outlet for research in all areas of economics based on
rigorous theoretical reasoning and on topics in mathematics that are supported by the
analysis of economic problems. Published articles contribute to the understanding and
solution of substantive economic problems.
Among the topics addressed in the journal are classical and modern equilibrium theory,
cooperative and non-cooperative game theory, macroeconomics, social choice and
welfare, uncertainty and information, intertemporal economics (including dynamical
systems), public economics , international and developmental economics, financial
economics, money and banking , and industrial organization.
In addition to original research articles, Economic Theory publishes surveys for particular
areas of research that clearly set forth the basic underlying concepts and ideas, the
essential technical apparatuses, and the central open questions.
iii) Phillips curve
AnsIn economics, the Phillips curve is a historical inverse relationship between the rate
of unemployment and the rate of inflation in an economy. Stated simply, lower
unemployment in an economy is correlated with a higher rate of inflation.
While there is a short run tradeoff between unemployment and inflation, it has not been
observed in the long run.[1] Accordingly, the Phillips curve is now seen as too simplistic,
with the unemployment rate supplanted by more accurate predictors of inflation based on
velocity supply measures such as the MZM ("money zero maturity") velocity,[2] which is
affected by unemployment in the short but not the long term.
8. Differentiate between the following
i) Income effect and substitution effect

AnsIncome Effect
The income effect is defined as the result of a change in a product's price relative to the
consumer's disposable income. When the price of a good changes, the real, or actual,
income of the consumer who wants that good changes. If the price goes up, then the
consumer is worse off, since he has less disposable income. Therefore, he can buy less of
the good, or not buy it at all.
Substitution Effect
The substitution effect occurs when, as the result of a price increase, the consumer will
substitute another product in its place, or forgo the product altogether. This concept,
however, depends on what sort of product has gone up in price, and how the consumer
views that product. If the product is a necessity, then the substitution effect will become
clear, since the consumer, who cannot do without the product, will shift, or substitute, a
lower-cost version of the same item.
ii) Public goods and Merit goods
AnsPublic goods
Public goods are goods that would not be provided in a free market system, because firms
would not be able to adequately charge for them. This situation arises because public
goods have two particular characteristics. They are:
1. Non-excludable - once the goods are provided, it is not possible to exclude people
from using them even if they haven't paid. This allows 'free-riders' to consume the
good without paying.
2. Non-rival - this means that consumption of the goods by one person does not
diminish the amount available for the next person.
Merit goods
Merit goods are goods that would be provided in a free market system, but would almost
certainly be under-provided. Take the case of education. If there were no state education
provided at all, there would still be private schools for those who could afford them, and
indeed many new private schools might open. However, there would not be nearly enough
education provided for everyone to benefit. This happens because the market only takes
account of the private costs and benefits. It does not take account of the external
benefits that may arise to society from everyone being educated. For this reason, merit
goods will be under-provided by the market.
iii) Multiplier and Accelerator.
AnsA multiplier is essentially just a ratio of change (it can be positive or negative, an
increment or a decrement) in income. It is a way of gauging shifts in investment spending.

For example, suppose variable x changes by 1 unit, which causes another variable y to
change by M units. Then the multiplier is M.
The accelerator is the term used to describe the economic effect that private investment
has on the growth of a market. This can be measured in terms of GNP (Gross National
Product).
For example, would it be better to use tax cuts to create more disposable income for
consumers who would then demand more products, or would it be faster to give those cuts
to business, which will then be able to use more capital for growth? Every government
and their economists create their own interpretation of accelerator theory and the questions
it can be used to answer.