BECC-101 : INTRODUCTORY MICROECONOMICS

Tutor Marked Assignments

Course Code: BECC-101
Assignment Code: Asst /TMA /2021-22
Total Marks: 100

Assignment One

Answer the following Descriptive Category questions in about 500 words each. Each question
carries 20 marks. Word limit does not apply in application part of the question.

2 × 20=40

1. (a) The Organisation of Petroleum Exporting Countries (OPEC) is an example of which

form of market structure? Discuss its characteristic features. 10

(b) Using an appropriate diagram discuss Paul Sweezy’s Kinked Demand curve theory.
10

2. (a) What are the assumptions of Indifference curve analysis of consumer equilibrium? 5

(b) Giffen goods must be inferior goods, while inferior goods, may or may not be Giffen goods.
Do you agree? Comment. 4

(c) Consider a consumer with income Rs 100. There are two commodities 1 and 2 to
choose from. If the consumer spends all his income on good 1, he can buy 5 units of it. If
he spends all his income on good 2, he can buy 20 units of it. Based on the given
information, attempt the following:

(i) Write the equation of the budget constraint. Also, construct a budget line taking good 1
on the horizontal and good 2 on the vertical axis. What will be the slope of this budget
line? 4

(ii) Suppose that in equilibrium this individual consumes 2 units of good 1 and 12 units of
good 2. Plot this bundle in the same diagram. Draw a convex shaped indifference curve
passing through this point. 3

(iii) Now suppose that income goes up to Rs 150. Illustrate how the budget constraint will
change. If both goods are normal, mark the region on the new budget line where the new
equilibrium will be? 4
 Assignment Two-

Answer the following Middle Category questions in about 250 words each. Each question carries
10 marks. Word limit does not apply in application part of the question.
3 × 10 = 30

3. (a) Consider the figure below where line D represents demand curve facing a
monopolist, MR and MC represent the marginal revenue and the marginal cost curve,
respectively.
Profit, Revenue, Cost

MC
A
P1
E
P2 C
P3 B
D
M
O Q1R Q2 Quantity
Answer the following:

(i) Which point depicts the monopoly equilibrium in the above figure? What will be the
price charged and quantity produced by this monopolist? 2

(ii) What would have been the equilibrium output and price had it been a perfect
competitive industry? Compare your result with that of a monopoly. 2

(b) Why a monopolist does not produce on the inelastic part of its demand curve? 3

(c) A monopolist has cost function TC = 10 + 2Q, where TC is the total cost of producing
Q units of output. Demand in this market is given by theequation Q = 14 – P, where P
stands for the price. Calculate the profit that the monopolist will be making. 3

4. (a) Consider the following Table which gives figures relating to the output of a commodity. The
inputs used include, Land (which is fixed) and Labour (which is a variable factor).

No. of Labourers Total Product

0 0
1 12
2 16
3 22
4 26
5 28
6 28
7 24
8 18
 Based on the above table, attempt the following:

(i) Mark the three stages of law of variable proportion in the above table. 2
(ii) In which stage will a rational producer choose to operate? Give reason. 3

(b)What are the reasons behind varying returns viz., increasing, constant and decreasing returns
to a factor in production in the short-run? Will such varying returns to a factor hold in the long-
run? 5

5. (a) Negative production externality leads to over-production. Do you agree? Illustrate

using an appropriate diagram. 5

(b) What role do taxes or subsidies play in internalising the externality that exists? 5

Assignment Three

Answer the following Short Category questions in about 100 words each. Each question carries 6
marks.
5 × 6 = 30

6. What causes a backward bending labor supply curve? 6

7. Compare and contrast Marshallian theory with the Ricardian theory of rent. 6
8. Explain the concept of Derived demand of the factor of production. 6
9. What is the rationale behind the rationing system for allocation of scarce resources? 6
10. Explain the Second Fundamental Theorem of Welfare Economics. 6
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ASSIGNMENT SOLUTIONS GUIDE (2021-22)

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BECC-101: INTRODUCTORY MICROECONOMICS

Disclaimer/Special Note: These are just the sample of the Answers/Solutions to some of the Questions
given in the Assignments. These Sample Answers/Solutions are prepared by Private
Teacher/Tutors/Authors for the help and guidance of the student to get an idea of how he/she can
answer the Questions given the Assignments. We do not claim 100% accuracy of these sample

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answers as these are based on the knowledge and capability of Private Teacher/Tutor. Sample
answers may be seen as the Guide/Help for the reference to prepare the answers of the Questions
given in the assignment. As these solutions and answers are prepared by the private teacher/tutor so
the chances of error or mistake cannot be denied. Any Omission or Error is highly regretted though

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every care has been taken while preparing these Sample Answers/Solutions. Please consult your own
Teacher/Tutor before you prepare a Particular Answer and for up-to-date and exact information, data
and solution. Student should must read and refer the official study material provided by the
university.
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Assignment One
Answer the following Descriptive Category questions in about 500 words each. Each question
carries 20 marks. Word limit does not apply in application part of the question.
Q1. (a) The Organisation of Petroleum Exporting Countries (OPEC) is an example of which form of
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market structure? Discuss its characteristic features.

Ans. The Organization of Petroleum Exporting Countries is an example of an international cartel. The
organization was created at a conference in Baghdad, Iraq on September 10th-14th, 1960. The
founding members which include Iran, Iraq, Kuwait, Saudi Arabia and Venezuela agreed to create an
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organization that could bring some degree of stability to the world oil market. OPEC agreed to
coordinate energy policies to ensure a fair price for their exported oil and a steady supply to
the market.[2] The governments of the OPEC countries agreed to coordinate with petroleum firms
(both state owned and private) in order to manipulate the worldwide oil supply and therefore the
price of oil.
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When firms agree to collude, that is they agree to a certain price and quantity for a good or service,
they create a cartel. A cartel is a type of oligopoly. As cartels are formed and operate in secret, it is up
to the members of the cartel to keep their agreement in tact. The firms must trust each other not to
drop their price to undercut the others or increase their output.[4] This is difficult to ensure as firms
may have different production costs and therefore require more of the profit to meet their costs.
Because of this, there is less control over the market than there would be under a monopoly structure.
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The term Organization of the Petroleum Exporting Countries (OPEC) refers to a group of 13 of the
world’s major oil-exporting nations. OPEC was founded in 1960 to coordinate the petroleum policies
of its members and to provide member states with technical and economic aid.1 OPEC is a cartel that
aims to manage the supply of oil in an effort to set the price of oil on the world market, in order to
avoid fluctuations that might affect the economies of both producing and purchasing countries.
Countries that belong to OPEC include Iran, Iraq, Kuwait, Saudi Arabia, and Venezuela (the five
founders), plus the United Arab Emirates, Libya, Algeria, Nigeria, and four other countries.
Understanding the Organization of the Petroleum Exporting Countries (OPEC)

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OPEC, which describes itself as a permanent intergovernmental organization, was created in
Baghdad in September 1960 by founding members Iran, Iraq, Kuwait, Saudi Arabia, and
Venezuela. The headquarters of the organization are in Vienna, Austria, where the OPEC Secretariat,
the executive organ, carries out OPEC’s day-to-day business
The chief executive officer of OPEC is its secretary-general.5 His Excellency Mohammad Sanusi

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Barkindo of Nigeria was appointed to the position for a three-year term of office on Aug. 1, 2016, and
was re-elected to another three-year term on July 2, 2019.
According to its statutes, OPEC membership is open to any country that is a substantial exporter of
oil and shares the ideals of the organization. After the five founding members, OPEC added 11
additional member countries as of 2019. They are, in order of joining, as follows:
• Qatar (1961)

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• Indonesia (1962)
• Libya (1962)
• United Arab Emirates (1967)
• Algeria (1969)
• Nigeria (1971)
• Ecuador (1973)

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• Gabon (1975)
• Angola (2007)
• Equatorial Guinea (2017)
• Congo (2018)
Ecuador withdrew from the organization on Jan. 1, 2020. Qatar terminated its membership on Jan. 1,
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2019, and Indonesia suspended its membership on Nov. 30, 2016, so as of 2020 the organization
consists of 13 states.
It is notable that some of the world’s largest oil producers, including Russia, China, and the United
States, are not members of OPEC, which leaves them free to pursue their own objectives.
OPEC's Mission
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According to the OPEC website, the group's mission is “to coordinate and unify the petroleum
policies of its Member Countries and ensure the stabilization of oil markets in order to secure an
efficient, economic, and regular supply of petroleum to consumers, a steady income to producers, and
a fair return on capital for those investing in the petroleum industry.”3
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The organization is committed to finding ways to ensure that oil prices are stabilized in the
international market without any major fluctuations. Doing this helps keep the interests of member
nations while ensuring they receive a regular stream of income from an uninterrupted supply of
crude oil to other countries.9
OPEC recognizes the founding nations as full members. Any country that wishes to join and whose
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application is accepted by the organization is also considered a full member. These countries must
have significant crude petroleum exports. Membership to OPEC is only granted after receiving a vote
from at least three-quarters of its full members. Associate memberships are also granted to countries
under special conditions.
(b) Using an appropriate diagram discuss Paul Sweezy’s Kinked Demand curve theory.
Ans. Under oligopoly, prices and output are indeterminate. Moreover, organizations are mutually
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dependent on each other in setting the pricing policy.

Therefore, economists found it extremely difficult to propound any specific theory for price and
output determination under oligopoly.
In the words of Maurice, “there is no theory of oligopoly in the sense that there is a theory of perfect
competition or of monopoly. There is no unique general solution but merely many different
behavioral models, each of which reaches a different solution.” Thus, the economists have developed
various analytical models based on different behavioral assumptions for determining price and
output under oligopoly.
Figure-1 shows different oligopoly models:

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Let us discuss different oligopoly models (as shown in Figure-1).
1. Sweezy’s Kinked Demand Curve Model: The kinked demand curve of oligopoly was developed
by Paul M. Sweezy in 1939. Instead of laying emphasis on price-output determination, the model
explains the behavior of oligopolistic organizations. The model advocates that the behavior of
oligopolistic organizations remain stable when the price and output are determined.

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This implies that an oligopolistic market is characterized by a certain degree of price rigidity or
stability, especially when there is a change in prices in downward direction. For example, if an
organization under oligopoly reduces price of products, the competitor organizations would also
follow it and neutralize the expected gain from the price reduction.
On the other hand, if the organization increases the price, the competitor organizations would also cut

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down their prices. In such a case, the organization that has raised its prices would lose some part of
its market share.
The kinked demand curve model seeks to explain the reason of price rigidity under oligopolistic
market situations. Therefore, to understand the kinked demand curve model, it is important to note
the reactions of rival organizations on the price changes made by respective oligopolistic
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organizations.
There can be two possible reactions of rival organizations when there are changes in the price of a
particular oligopolistic organization. The rival organizations would either follow price cuts, but not
price hikes or they may not follow changes in prices at all.
A kinked demand curve represents the behavior pattern of oligopolistic organizations in which rival
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organizations lower down the prices to secure their market share, but restrict an increase in the prices.
Following are the assumption of a kinked demand curve:
i. Assumes that if one oligopolistic organization reduces the prices, then other organizations would
also cut their prices
ii. Assumes that if one oligopolistic organization increases the prices, then other organizations would
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not follow increase in prices

iii. Assumes that there is always a prevailing price
A kinked demand curve model is explained with the help of Figure-2:
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The slope of a kinked demand curve differs in different conditions, such as price increase and price
decrease. In this model, every organization faces two demand curves. In case of high prices, an
oligopolistic organization faces highly elastic demand curve, which is dd’ in Figure-2.
On the other hand, in case of low prices, the oligopolistic organization faces inelastic demand curve,
which is DD’ (Figure-2). Suppose the prevailing price of a product is PQ, as shown in Figure-2. If one

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of the oligopolistic organizations makes changes in its prices, then there can be three reactions of rival
organizations.
Firstly, when the oligopolistic organization would increase its prices, its demand curve would shift to
dd’ from DD’. In such a case, consumers would switch to rivals, which would lead to fall in the sales
of the oligopolistic organization. In addition, the dP portion of dd’ would be more elastic, which lies

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above the prevailing price.
On the other hand, if price falls, the rivals would also reduce their prices, thus, the sales of the
oligopolistic organization would be less. In such a case, the demand curve faced by the oligopolistic
organization is PD’, which lies below the prevailing price.
Secondly, rival organizations will not react with respect to changes in the price of the oligopolistic
organization. In such a case, the oligopolistic organization would face DD’ demand curve.

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Thirdly, the rival organizations may follow price cut, but not price hike. If the oligopolistic
organization increases the price and rivals do not follow it, then consumers may switch to rivals.
Thus, the rivals would gain control over the market. Thus, the oligopolistic organization would be
forced from dP demand curve to DP demand curve, so that it can prevent losing its customers.
This would result in producing the kinked demand curve. On the other hand, if the oligopolistic
organization reduces the price, the rival organizations would also reduce prices for securing their

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customers. Here, the relevant demand curve is Pd’. The two parts of the demand curve are DP and
Pd’, which is DPd’ with a kink at point P.
Let us draw the MR curve of the oligopolistic organization. The MR curve would take the
discontinuous shape, which is DXYC, where DX and YC correspond directly to DP and Pd’ segments
of the kinked demand curve. The equilibrium point is attained when MR = MC. In Figure-2, the MC
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curve intersects MR at point Y where at output OQ.
At point Y, the organization would achieve maximum profit. Now, if cost increases, the MC curve
would move upwards to MC. In such a case, the oligopolistic organization cannot increase the prices.
This is because if the organization would increase the prices, the rival organizations would decrease
their prices and gain the market share. Moreover, the profits would remain same between point X and
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Y. Thus, there is no motivation for increasing or decreasing prices. Therefore, price and output would
remain stable.
However, kinked demand curve model is criticized by various economists.
Some of the major points of criticism are as follows:
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i. Lays emphasis on price rigidity, but does not explain price itself.
ii. Assumes that rival organizations only follow price decrease, which does not hold true empirically.
iii. Ignores non-price competition among organizations. Non-price competition can be in terms of
product differentiation, advertising, and other tools used by organizations to promote their sales.
iv. Ignores the application of price leadership and cartels, which account for larger share of the
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oligopolistic market.
2. Collusion Model-The Cartel: In oligopolistic market situations, organizations are indulged in high
competition with each other, which may lead to price wars. For avoiding such type of problems,
organizations enter into an agreement regarding uniform price-output policy. This agreement is
known as collusion, which is opposite to competition. Under collusion, organizations are involved in
collaboration with each other to take combined actions for keeping their bargaining power stronger
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against consumers.
Some of the popular definitions of collusion are as follows:
According to Samuelson, “Collusion denotes a situation in which two or more firms jointly set that
prices or output, divide the market among them, or make other business decisions.”
In the words of Thomas J. Webster, “Collusion represents a formal agreement among firms in an
oligopolistic industry to restrict competition to increase industry profits.”
Collusion helps oligopolistic organizations in many ways.
Some of the benefits of collusion are as follows:
• Helps organizations to increase their performance

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• Helps organizations in preventing uncertainties
• Provides opportunities to prevent the entry of new organizations
The agreement of collusion formed may be tacit or formal in nature. A formal agreement formed
among competing organizations is known as cartel. In other words, cartel can be defined as a group
of organizations that together make pricing and output decisions.

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Some of the management experts have defined cartel in the following ways:
According to Leftwitch, “the firms jointly establish a cartel organization to make price and output
decisions, to establish production quotas for each firm, and to supervise market activities of the firms
in the industry.”
According to Khemani and Shapiro, “Cartels are productive structures involving multiple producers
acting in unison that allow producers to exercise monopoly power.”

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In the words of Boyce and Melvin, “A cartel is an organization of independent firms, whose purpose
is to control and limit production and maintain or increase prices and profits.”
According to Webster, “A cartel is a formal agreement among firms in an oligopolistic industry to
allocate market share and/or industry profit.”
Under cartels, the price and output determination is done by the common administrative authority,
which aims at equal profit distribution among all member organizations under cartel. The total profits

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are distributed in proportion as decided among member organizations. The most famous example of
cartel is Organization of the Petroleum Exporting Countries (OPEC), which has shared control of
petroleum markets.
Let us understand price and output decisions under cartels with the help of an example. Assume that
there are two organizations that have formed a cartel.
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The price and output decisions of these two organizations are shown in Figure-3:
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In Figure-3 (c), AR is the aggregate demand curve of both the organizations and MC curves are the
addition of MC1 and MC2 curves of organizations A and B, respectively. The total output of industry
is determined according to MR and MC of the industry. In Figure-3 (c), OQ and OP are the
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equilibrium price and output of the industry.

Now, this output will be allocated among the organizations. This can be done by drawing a
horizontal line from equilibrium point E of industry, towards MC curves of organizations A and B.
The points of intersection E1 and E2 are the equilibrium levels of the organizations, A and B,
respectively. OQ1 is the equilibrium output of organization A and OQ2 is the equilibrium output of
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organization B. Thus, OQ1 + OQ2 = OQ. These levels of outputs ensure the maximum joint profits of
member organizations.

Q2. (a) What are the assumptions of Indifference curve analysis of consumer equilibrium?
Ans. An indifference curve, with respect to two commodities, is a graph showing those combinations
of the two commodities that leave the consumer equally well off or equally satisfied—hence
indifferent—in having any combination on the curve.

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Indifference curves are heuristic devices used in contemporary microeconomics to demonstrate
consumer preference and the limitations of a budget. Economists have adopted the principles of
indifference curves in the study of welfare economics.
Understanding an Indifference Curve: Standard indifference curve analysis operates on a simple
two-dimensional graph. Each axis represents one type of economic good. Along the indifference

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curve, the consumer is indifferent between any of the combinations of goods represented by points on
the curve because the combination of goods on an indifference curve provide the same level of utility
to the consumer.
For example, a young boy might be indifferent between possessing two comic books and one toy
truck, or four toy trucks and one comic book so both of these combinations would be points on an
indifference curve of the young boy.

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Indifference Curve Analysis: Indifference curves operate under many assumptions; for example,
typically each indifference curve is convex to the origin, and no two indifference curves ever intersect.
Consumers are always assumed to be more satisfied when achieving bundles of goods on indifference
curves that are farther from the origin.
As income increases, an individual will typically shift their consumption level because they can afford
more commodities, with the result that they will end up on an indifference curve that is farther from

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the origin—hence better off.
Many core principles of microeconomics appear in indifference curve analysis, including individual
choice, marginal utility theory, income, substitution effects, and the subjective theory of value.
Indifference curve analysis emphasizes marginal rates of substitution (MRS) and opportunity costs.
Indifference curve analysis typically assumes all other variables are constant or stable.
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Most economic textbooks build upon indifference curves to introduce the optimal choice of goods for
any consumer based on that consumer's income. Classic analysis suggests that the optimal
consumption bundle takes place at the point where a consumer's indifference curve is tangent with
their budget constraint.
The slope of the indifference curve is known as the MRS. The MRS is the rate at which the consumer
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is willing to give up one good for another. If the consumer values apples, for example, the consumer
will be slower to give them up for oranges, and the slope will reflect this rate of substitution.
Criticisms and Complications of the Indifference Curve: Indifference curves, like many aspects of
contemporary economics, have been criticized for oversimplifying or making unrealistic assumptions
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about human behavior. For example, consumer preferences might change between two different
points in time rendering specific indifference curves practically useless.
Other critics note that it is theoretically possible to have concave indifference curves or even circular
curves that are either convex or concave to the origin at various points. Consumer preferences might
also change between two different points in time rendering specific indifference curves practically
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useless.
(b) Giffen goods must be inferior goods, while inferior goods, may or may not be Giffen goods.
Do you agree? Comment.
Ans. Yes. Because Giffen goods, by definition, are those inferior goods in case of which two
conditions are satisfied: (i) income effect is negative, and (ii) income effect is greater than substitution
effect. In the case of inferior goods, on the other hand, only one condition needs to be satisfied: that
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income effect is negative.

(c) Consider a consumer with income Rs 100. There are two commodities 1 and 2 to choose from. If
the consumer spends all his income on good 1, he can buy 5 units of it. If he spends all his income
on good 2, he can buy 20 units of it. Based on the given information, attempt the following:
(i) Write the equation of the budget constraint. Also, construct a budget line taking good 1 on the
horizontal and good 2 on the vertical axis. What will be the slope of this budget line?
Ans. The concept of consumer preferences is integral to understanding consumer budget. In
microeconomics, we understand consumer preferences using two goods, say 1 and 2. Let their prices

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be P1 and P2 and their quantities consumed be X1 and X2. To understand the budget, we must
introduce the idea of money income of the consumer. Let that be denoted by ‘M’.
Consumer preferences are denoted by quantities of the two goods consumers are willing to purchase
depicted using ‘bundles’. A bundle is a combination of good 1 and 2, written as (good 1, good 2).
Thus, a bundle written as (1,2) means 1 unit of good 1 and 2 units of good 2. Similarly, (3,7); (8,4) are

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also bundles with different quantities of good 1 and 2.
(ii) Suppose that in equilibrium this individual consumes 2 units of good 1 and 12 units of good 2.
Plot this bundle in the same diagram. Draw a convex shaped indifference curve passing through
this point.
Ans. People cannot really put a numerical value on their level of satisfaction. However, they can, and
do, identify what choices would give them more, or less, or the same amount of satisfaction. An

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indifference curve shows all combinations of goods that provide an equal level of utility or
satisfaction.
For example, Figure 1 presents three indifference curves that represent Lilly’s preferences for the
tradeoffs that she faces in her two main relaxation activities: eating doughnuts and reading paperback
books. Each indifference curve (Ul, Um, and Uh) represents one level of utility. First we will explore
the meaning of an individual indifference curve and then we will look at the relationship between

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different indifference curves.
(iii) Now suppose that income goes up to Rs 150. Illustrate how the budget constraint will change.
If both goods are normal, mark the region on the new budget line where the new equilibrium will
be?
Ans. Just as utility and marginal utility can be used to discuss making consumer choices along a
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budget constraint, these ideas can also be used to think about how consumer choices change when the
budget constraint shifts in response to changes in income or price. Indeed, because the budget
constraint framework can be used to analyze how quantities demanded change because of price
movements, the budget constraint model can illustrate the underlying logic behind demand curves.
For analyzing the possible effect of a change in price on consumption, let’s again use a concrete
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example. represents the consumer choice of Sergei, who chooses between purchasing baseball bats
and cameras. A price increase for baseball bats would have no effect on the ability to purchase
cameras, but it would reduce the number of bats Sergei could afford to buy. Thus a price increase for
baseball bats, the good on the horizontal axis, causes the budget constraint to rotate inward, as if on a
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hinge, from the vertical axis. As in the previous section, the point labeled M represents the originally
preferred point on the original budget constraint, which Sergei has chosen after contemplating his
total utility and marginal utility and the tradeoffs involved along the budget constraint. In this
example, the units along the horizontal and vertical axes are not numbered, so the discussion must
focus on whether more or less of certain goods will be consumed, not on numerical amounts.
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Assignment Two
Answer the following Middle Category questions in about 250 words each. Each question carries
10 marks. Word limit does not apply in application part of the question.
Q3. (a) Consider the figure below where line D represents demand curve facing a monopolist, MR
and MC represent the marginal revenue and the marginal cost curve, respectively.
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Answer the following:
(i) Which point depicts the monopoly equilibrium in the above figure? What will be the price
charged and quantity produced by this monopolist?
Ans. Monopolies, as opposed to perfectly competitive markets, have high barriers to entry and a
single producer that acts as a price maker.

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(ii) What would have been the equilibrium output and price had it been a perfect competitive
industry? Compare your result with that of a monopoly.
Ans. The fact that price in monopoly exceeds marginal cost suggests that the monopoly solution
violates the basic condition for economic efficiency, that the price system must confront decision
makers with all of the costs and all of the benefits of their choices. Efficiency requires that consumers
confront prices that equal marginal costs. Because a monopoly firm charges a price greater than

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marginal cost, consumers will consume less of the monopoly’s good or service than is economically
efficient.
To contrast the efficiency of the perfectly competitive outcome with the inefficiency of the monopoly
outcome, imagine a perfectly competitive industry whose solution is depicted in Figure 10.7 “Perfect
Competition, Monopoly, and Efficiency”. The short-run industry supply curve is the summation of
individual marginal cost curves; it may be regarded as the marginal cost curve for the industry. A

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perfectly competitive industry achieves equilibrium at point C, at price Pc and quantity Qc.
(b) Why a monopolist does not produce on the inelastic part of its demand curve?
Ans. The first thing to remember is that monopolist choose the quantity to produce so that marginal
revenue is equal to marginal cost. If marginal revenue is less than marginal cost, then if the
monopolist sold one fewer unit, the costs would decrease more than the revenue and profits will
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increase (conversely, if marginal revenue is greater than marginal cost, then if the monopolist sold
one more unit, revenue would go up more than costs and profits would increase in this case as well).
As it turns out, total revenue is maximized where the price elasticity of demand is -1. What this
means is that total revenue decreases if the firm moves into the inelastic portion of the demand curve,
so marginal revenue is negative. Intuitively, in the inelastic portion of the demand curve, prices drop
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by a greater percentage than quantity increases, which causes total revenue to fall.
A monopolist would never want to produce where marginal revenue is negative. Because marginal
revenue is negative and marginal costs must be at least zero, at this point marginal revenue MUST be
less than marginal cost, so the monopolist should produce less.
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(c) A monopolist has cost function TC = 10 + 2Q, where TC is the total cost of producing Q units of
output. Demand in this market is given by the equation Q = 14 – P, where P stands for the price.
Calculate the profit that the monopolist will be making.
Ans. Same as
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Q4. (a) Consider the following Table which gives figures relating to the output of a commodity.
The inputs used include, Land (which is fixed) and Labour (which is a variable factor).
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Based on the above table, attempt the following:

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(i) Mark the three stages of law of variable proportion in the above table.
Ans. This production process exhibits diminishing returns to labor. The marginal product of labor,
the extra output produced by each additional worker, diminishes as workers are added, and is
actually negative for the sixth and seventh workers.
(ii) In which stage will a rational producer choose to operate? Give reason.
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Ans. Labor’s negative marginal product for L > 5 may arise from congestion in the chair
manufacturer’s factory. Since more laborers are using the same, fixed amount of capital, it is possible
that they could get in each other’s way, decreasing efficiency and the amount of output.
(b)What are the reasons behind varying returns viz., increasing, constant and decreasing returns to
a factor in production in the short-run? Will such varying returns to a factor hold in the long-run?
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Ans. Diminishing Marginal Returns vs. Returns to Scale: An Overview

In business, it is important to reach a level of optimal production. This ensures that all factors of
production are being used in their best capacity. Making adjustments to the factors of production, or
inputs, has varying effects and can be analyzed in different ways.
Diminishing marginal returns is an effect of increasing input in the short run after an optimal capacity
has been reached while at least one production variable is kept constant, such as labor or capital. The
law states that this increase in input will actually result in smaller increases in output. Returns to scale
measures the change in productivity from increasing all inputs of production in the long run.
Diminishing Marginal Returns: The law of diminishing marginal returns states that with every
additional unit in one factor of production, while all other factors are held constant, the incremental

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output per unit will decrease at some point. The law of diminishing marginal returns does not
necessarily mean that increasing one factor will decrease overall total production, which would
be negative returns, but this outcome usually occurs.
Reducing the impact of the law of diminishing marginal returns may require discovering the
underlying causes of production decreases. Businesses should carefully examine the production

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supply chain for instances of redundancy or production activities interfering with each other.
For example, a restaurant hiring more cooks while keeping the same kitchen space can increase total
output to a point, but every additional cook takes up space, eventually leading to smaller increases in
output as there are too many cooks in the kitchen. The total output can decrease at some point,
resulting in negative returns if too many cooks get in each other's way and eventually become
unproductive.

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By reversing the law of diminishing returns, if production units are removed from one factor, the
impact on production is minimal for the first few units and may result in substantial cost savings. For
example, if a restaurant removes a few cooks rather than hiring more, it may realize cost savings
without experiencing significantly diminished production.
Returns to Scale: On the other hand, returns to scale refers to the proportion between the increase in
total input and the resulting increase in output. There are three kinds of returns to scale: constant

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returns to scale (CRS), increasing returns to scale (IRS), and decreasing returns to scale (DRS).
A constant returns to scale is when an increase in input results in a proportional increase in output.
Increasing returns to scale is when the output increases in a greater proportion than the increase in
input. Decreasing returns to scale is when all production variables are increased by a certain
percentage resulting in a less-than-proportional increase in output.
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For example, if a soap manufacturer doubles its total input but gets only a 40% increase in total
output, then it can be said to have experienced decreasing returns to scale. If the same manufacturer
ends up doubling its total output, then it has achieved constant returns to scale. If the output
increased by 120%, then the manufacturer experienced increasing returns to scale.
Key Differences: Though both diminishing marginal returns and returns to scale look at how output
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changes are affected by changes in input, there are key differences between the two that need to be
considered.
Diminishing marginal returns primarily looks at changes in variable inputs and is therefore a short-
term metric. Variable inputs are easier to change in a short time horizon when compared to fixed
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inputs. As such, returns to scale is a measure focused on changing fixed inputs and is therefore a
long-term metric.
Both metrics show that an increase in input will increase output up until a point, the main difference
between the two is the time horizon and therefore the inputs that can be changed: variable or fixed.
Understanding both and their differences is important for firms in their decision-making process to
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reach optimal levels of production and cost efficiency.

Q5. (a) Negative production externality leads to over-production. Do you agree? Illustrate using an
appropriate diagram.
Ans. Externalities can be both positive and negative. They exist when the actions of one person or
entity affect the existence and well-being of another. In economics, there are four different types
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of externalities: positive consumption and positive production, and negative consumption and
negative production externalities. As implied by their names, positive externalities generally have a
positive effect, while negative ones have the opposite impact. But how do these economic factors
affect market prices and market failure? Read on to find out more about externalities and their impact
on the market.
An externality is a cost or benefit that stems from the production or consumption of a good or service.
Externalities, which can be both positive or negative, can affect an individual or single entity, or it can
affect society as a whole. The benefactor of the externality—usually a third party—has no control over
and never chooses to incur the cost or benefit.

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Negative externalities usually come at the cost of individuals, while positive externalities generally
have a benefit. For example, a crematorium releases toxic gases such as mercury and carbon dioxide
into the air. This has a negative impact on people who may live in the area, causing them harm.
Pollution is another commonly known negative externality. Corporations and industries may try to
curb their costs by putting in production measures that may have a detrimental effect on the

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environment. While this may decrease the cost of production and increase revenues, it also has a cost
to the environment as well as society.
Meanwhile, establishing more green spaces in a community brings more benefit to those living there.
Another positive externality is the investment in education. When education is easy to access and
affordable, society benefits as a whole. People are able to command higher wages, while employers
have a labor pool that's knowledgeable and trained.

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Governments may choose to remove or reduce negative externalities through taxation and regulation,
so heavy pollutants, for example, may be taxed and subject to more scrutiny. Those who create
positive externalities, on the other hand, may be rewarded with subsidies.
Externalities and Market Failure: Externalities lead to market failure because a product or service's
price equilibrium does not accurately reflect the true costs and benefits of that product or service.
Equilibrium, which represents the ideal balance between buyers' benefits and producers' costs, is

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supposed to result in the optimal level of production. However, the equilibrium level is flawed when
there are significant externalities, creating incentives that drive individual actors to make decisions
which end up making the group worse off. This is known as a market failure.
Negative Externalities: When negative externalities are present, it means the producer does not bear
all costs, which results in excess production. With positive externalities, the buyer does not get all the
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benefits of the good, resulting in decreased production. Let's look at a negative externality example of
a factory that produces widgets. Remember, it pollutes the environment during the production
process. The cost of the pollution is not borne by the factory, but instead shared by society.
If the negative externality is taken into account, then the cost of the widget would be higher. This
would result in decreased production and a more efficient equilibrium. In this case, the market failure
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would be too much production and a price that didn't match the true cost of production, as well as
high levels of pollution.
Positive Externalities: Now let's take a look at the relationship between positive externalities like
education and market failure. Obviously, the person being educated benefits and pays for this cost.
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However, there are positive externalities beyond the person being educated, such as a more
intelligent and knowledgeable citizenry, increased tax revenues from better-paying jobs, less crime,
and more stability. All of these factors positively correlate with education levels. These benefits to
society are not accounted for when the consumer considers the benefits of education.
Therefore, education would be under-consumed relative to its equilibrium level if these benefits are
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taken into account. Clearly, public policymakers should look to subsidize markets with positive
externalities and punish those with negative externalities.
Challenges: One obstacle for policymakers, though, is the difficulty of quantifying externalities to
increase or decrease consumption or production. In the case of pollution, policymakers have tried
tools—including mandates, incentives, penalties and taxes—that would result in increased costs of
production for companies that pollute. For education, policymakers have looked to increase
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consumption with subsidies, access to credit, and public education.

In addition to positive and negative externalities, some other reasons for market failure include a lack
of public goods, under provision of goods, overly harsh penalties, and monopolies. Markets are the
most efficient way to allocate resources with the assumption that all costs and benefits are accounted
into price. When this is not the case, significant costs are inflicted upon society, as there will be
underproduction or overproduction.
The Bottom Line: Being cognizant of externalities is one important step in combating market failure.
While price discovery and resource allocation mechanisms of markets need to be respected, market

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equilibrium is a balance between costs and benefits to the producer and consumer. It does not
take third parties into effect. Thus, it is the policymakers' responsibility to adjust costs and benefits in
an optimal way.
(b) What role do taxes or subsidies play in internalising the externality that exists?
Ans. Positive externalities: A positive externality is a benefit that is enjoyed by a third-party as a

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result of an economic transaction. While individuals who benefit from positive externalities without
paying are considered to be free-riders, it may be in the interests of society to encourage free-riders to
consume goods which generate substantial external benefits.
As can be seen, most merit goods generate positive externalities, which beneficiaries do not pay for.
For example, with healthcare, private treatment for contagious diseases provides a considerable

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benefit to others, for which they do not pay. Similarly, with education, the skills acquired and
knowledge learnt at university can benefit the wider community in many ways. Unlike negative
externalities, which should be discouraged to achieve a socially efficient allocation of scarce resources,
positive externalities should be encouraged.
Encouraging positive externalities: One role for government is to implement economic policies that

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promote positive externalities. There are two general approaches to promoting positive externalities;
to increase the supply of, and increase the demand for, goods, services and resources that generate
external benefits.
Government grants and subsidies to producers of goods and services that generate external benefits
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will reduce costs of production, and encourage more supply. This is a common remedy to encourage
the supply of merit goods such as healthcare, education, and social housing. Such merit goods can be
funded out of central and local government taxation. Public goods, such as roads, bridges and
airports, also generate considerable positive externalities, and can be built, maintained and fully, or
part, funded out of tax revenue.
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Increasing demand: Demand for goods, which generate positive externalities, can be encouraged by
reducing the price paid by consumers. For example, subsidising the tuition fees of university students
will encourage more young people to go to university, which will generate a positive externality for
future generations.
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The ultimate encouragement to consume is to make the good completely free at the point of
consumption, such as with freely available hospital treatment for contagious diseases.
Government can also provide free information to consumers, to compensate for the information
failure that discourages consumption. If individuals are fully informed about the benefits of
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consuming goods and services that generate external benefits, they may develop a better
understanding of the product and demand more of it. For example, public information broadcasts,
such as aids awareness programmes, can reduce ignorance, and encourage the use of condoms.
An additional option is to compel individuals to consume the good or service that generates the
external benefit. For example, if suspected of having a contagious disease, an individual may be
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forced into hospital to receive treatment, even against their will. In terms of education, attendance at
school up until the age of 16 is compulsory, and parents may be fined for encouraging their children
to truant.
Net welfare loss: The existence of a positive externality means that marginal social benefit is greater
than marginal private benefit. For example, in considering the market for education, free markets
would supply quantity Q at price P. If the external benefit is included, the socially efficient output
rises to quantity Q1.

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By consuming only quantity Q, marginal social benefit is above marginal social cost, and more of the
good should be consumed. At Q, the marginal social cost is A (Q – A), and the private benefit is
also A (Q – A) but the marginal social benefit is C (Q – C). Therefore, if only Q is consumed, there is
an opportunity cost to society, which is represented by the area of welfare loss, A, C, B.
Positive production externalities: A positive production externality occurs when a third party gains
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as a result of production. However, those third parties who benefit cannot be charged, so there is only
an incentive to supply to those who can be charged.
Positive production externalities occur in many situations, most notably with the construction and
operation of infrastructure projects, such as a new airport, or motorway.
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Research and development which leads to new technology is also a potential by-product of production,
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which other firms can benefit from.

Assignment Three
Answer the following Short Category questions in about 100 words each. Each question carries 6
marks.
Q6. What causes a backward bending labor supply curve?
Ans. In economics, a backward-bending supply curve of labour, or backward-bending labour supply
curve, is a graphical device showing a situation in which as real wages increase beyond a certain
level, people will substitute leisure for paid worktime and so higher wages lead to a decrease in the
labour supply and so less labour-time being offered for sale.

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The "labour-leisure" tradeoff is the tradeoff faced by wage-earning human beings between the
amount of time spent engaged in wage-paying work and satisfaction-generating unpaid time, which
allows participation in "leisure" activities and the use of time to do necessary self-maintenance, such
as sleep. The key to the tradeoff is a comparison between the wage received from each hour of
working and the amount of satisfaction generated by the use of unpaid time.

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Such a comparison generally means that a higher wage entices people to spend more time working
for pay; the substitution effect implies a positively sloped labour supply curve. However, the
backward-bending labour supply curve occurs when an even higher wage actually entices people to
work less and consume more leisure or unpaid time.

Q7. Compare and contrast Marshallian theory with the Ricardian theory of rent.

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Ans.

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Q8. Explain the concept of Derived demand of the factor of production.
Ans. Derived demand is a term in economics that describes the demand for a certain good or service
resulting from a demand for related, necessary goods or services. For example, the demand for large-
screen televisions creates a derived demand for home theater products such as audio speakers,
amplifiers, and installation services.

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Derived demand exists only when a separate market exists for both related goods or services
involved. A product or service's level of derived demand has a significant impact on the market price
of that product or service.
Derived demand differs from regular demand, which is simply the quantity of a certain good or
service that consumers are willing to buy at a given price at a certain point in time. Under the theory
of regular demand, a product’s price is based on “whatever the market—meaning consumers—will

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bear.”
Components of Derived Demand
Derived demand can be broken down into three main elements: raw materials, processed materials,
and labor. These three components create what economists call the chain of derived demand.
Raw Materials
Raw or “unprocessed” materials are the elemental products used in the production of goods. For

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example, crude oil is a raw material in the production of petroleum products, such as gasoline. The
level of derived demand for a certain raw material is directly related to and dependent on the level of
demand for the final good to be produced. For example, when the demand for new homes is high, the
demand for harvested lumber will be high. Raw materials, like wheat and corn or often
called commodities.
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Processed Materials
Processed materials are goods that have been refined or otherwise assembled from raw materials.
Paper, glass, gasoline, milled lumber, and peanut oil are some examples of processed materials.
Labor
The production of goods and the provision of services requires workers—labor. The level of demand
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for labor depends solely on the level of demand for goods and services. Since there is no demand for a
workforce without a demand for the goods it produces or the services they provide, labor is a
component of derived demand.
The Chain of Derived Demand
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The chain of derived demand refers to the flow of raw materials to processed materials to labor to end
consumers. When consumers show a demand for a good, the necessary raw materials are harvested,
processed, and assembled. For example, consumer demand for clothing creates a demand for fabric.
To meet this demand, a raw material like cotton is harvested, then turned into processed materials
by ginning, spinning, and weaving into cloth, and finally sewn into the garments purchased by the
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end consumers.
Examples of Derived Demand
The theory of derived demand is as old as commerce itself. An early example was the “pick and
shovel” strategy during the California Gold Rush. When news of gold at Sutter’s Mill spread,
prospectors rushed to the area. However, to get the gold from the ground, the prospectors needed
picks, shovels, gold pans, and dozens of other supplies. Many historians of the era argue that the
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entrepreneurs who sold supplies to the prospectors saw more profits from the gold rush than the
average prospectors themselves. The sudden demand for the common processed materials—picks
and shovels—was derived from the sudden demand for the rare raw material—gold.
In a far more modern example, the demand for smartphones and similar devices has created a
tremendous derived demand for lithium-ion batteries. In addition, the demand for smartphones
creates a demand for other needed components like touch-sensitive glass screens, microchips, and
circuit boards, as well as raw materials like gold and copper need to make those chips and circuit
boards.

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Examples of derived demand for labor can be seen everywhere. The amazing demand for gourmet
brewed coffee leads to an equally-amazing demand for gourmet coffee brewers and servers called
baristas. Conversely, as the U.S. demand for coal used to generate electricity has declined, the
demand for coal miners has fallen.
The Economic Effects of Derived Demand

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Far beyond the industries, workers, and consumers directly involved, the chain of derived demand
can have a ripple effect on local and even national economies. For example, custom clothing sewn by
small local tailor may create a new local market for shoes, jewelry, and other high-end fashion
accessories.
On the national level, an increase in demand for raw materials like crude oil, lumber, or cotton, can
create vast new international demand trading markets for countries that enjoy an abundance of those

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materials.

Q9. What is the rationale behind the rationing system for allocation of scarce resources?
Ans. Rationing, government policy consisting of the planned and restrictive allocation of scarce
resources and consumer goods, usually practiced during times of war, famine, or some other national
emergency.

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Rationing may be of several types. Informal rationing, which precedes the imposition of formal
controls, may consist of admonitions to consumers to reduce their consumption or of independent
action taken by suppliers in allocating scarce supplies. Rationing according to use prohibits the less
important uses of a commodity. Rationing by quantity may limit the hours during which the
commodity is available or may assign quotas of a commodity to all known and approved claimants.
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Rationing by value limits the amount consumers may spend on commodities that cannot be
standardized, consumers being allowed to make their own selections within the value limits imposed.
Point rationing assigns a point value to each commodity and allocates a certain number of points to
each consumer; this system is employed during periods of critical and increasing shortages when
individuals begin substituting unrationed for rationed items, thereby spreading shortages.
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Consumers in a rationed economy are usually exhorted to save by purchasing government bonds or
by increasing their deposits in savings banks so that unspent money will not be used for increased
purchases of unrationed items or for purchases on the black market.
Currency, in industrialized nations, portion of the national money supply, consisting of bank notes
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and government-issued paper money and coins, that does not require endorsement in serving as a
medium of exchange; among less developed societies, currency encompasses a wide diversity of
items (e.g., livestock, stone carvings, tobacco) used as exchange media as well as signs of value or
wealth. In the developed nations, where checks drawn on demand deposits are an important means
of transaction, currency may actually account for only a small portion of the total money supply.
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Since the abandonment of the gold standard in the 1930s, governments have not been obligated to
repay the holders of currency in any form of precious metal. Consequently the volume of currency is
determined by the actions of the government or central bank and not by the supply of precious
metals.
Debt, Something owed. Anyone having borrowed money or goods from another owes a debt and is
under obligation to return the goods or repay the money, usually with interest. For governments, the
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need to borrow in order to finance a deficit budget has led to the development of various forms
of national debt. See also bankruptcy; debtor and creditor; usury.
Stock exchange, also called stock market, or (in continental Europe) bourse, organized market for the
sale and purchase of securities such as shares, stocks, and bonds.
In most countries the stock exchange has two important functions. As a ready market for securities, it
ensures their liquidity and thus encourages people to channel savings into corporate investment. As a
pricing mechanism, it allocates capital among firms by determining prices that reflect the true
investment value of a company’s stock. (Ideally, this price represents the present value of the stream
of expected income per share.) Membership requirements of stock exchanges vary among countries,

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mainly with respect to the number of members, the degree of bank participation, the rigour of the
eligibility requirements, and the level of government involvement. Trading is done in various ways: it
may occur on a continuous auction basis, involve brokers buying from and selling to dealers in
certain types of stock, or be conducted through specialists in a particular stock.
Technological developments have greatly influenced the nature of trading. By the 21st century,

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increased access to the Internet and the proliferation of electronic communications networks (ECNs)
had allowed electronic trading, or e-trading, to alter the investment world. These computerized ECNs
made it possible to match the orders of buyers and sellers of securities without the intervention of
specialists or market makers. In a traditional full-service or discount brokerage, a customer places an
order with a broker member of a stock exchange, who in turn passes it on to a specialist on the floor
of the exchange who actually concludes the transaction.

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The traditional specialist makes a market for a stock on the exchange by matching buy and sell orders
in his exclusive “book” and establishing a price for the trade. In the over-the-counter market, market
makers establish prices by setting “bid” and “asked” spreads with a commitment to complete trades
in a given security. In e-trading the customer enters an order directly online, and specialized software
automatically matches orders to achieve the best price available. In effect, the ECN is a stock exchange
for off-the-floor trading. As a result, the operations of some stock exchanges, such as NASDAQ, need

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not be centralized in one location but can be coordinated electronically from a number of locations.

Q10. Explain the Second Fundamental Theorem of Welfare Economics.

Ans. The second theorem of welfare economics has certain advantages over first theorem of welfare
economics. It explains that if all consumers have convex preferences and all firms have convex
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production possibility sets then Pareto efficient allocation can be achieved. The equilibrium of a
complete set of competitive markets are suitable for redistribution of initial endowments.
In the second welfare theorem, Pareto efficient allocation is A*. In such A* allocation, individual h has
consumption xh*. Firm j produces the output yj*. We know that at A* is a point where all consumers
will have the same marginal rates of substitution between all pairs of commodities. Let’s assume that
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pi denote the consumers’ marginal rate of substitution between commodity i and commodity 1.
We can represent it through equation as follows:

We can define above equation differently because right hand side of the equation is assumed as 1.
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We can interpret = 1(1, p2,….pn). It is the set of relative prices, with commodity 1. Suppose if we
redistribute the individual’s initial endowments into commodities and shareholdings then in terms of
equation, it can be written as,
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Where,
xh: h’s initial endowment after the redistribution,
βhj: The post redistribution shareholding in firm j
p yj: The profit earned by firm j.
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In the above equation, there are two apparent problems with this redistribution. In the original
explanation, individual’s initial endowments x̅h are consisting only of labor time. That it is not
possible to transfer such endowments from one individual to another. They are inseparable and
indivisible from one individual to another individual. Individual utilizes time for productive
purposes.
Firms also produce the goods with constant returns to scale. Firm has the breakeven point at yj*. It
also faces price and input cost. If we redistribute the shareholding of firm then it will not affect on
budget constraints. If the firm earns zero profit then also budget constraint will not get affected.

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For solving the problem of individual and firm, we need to use transfer T where Σh T = 0. It is
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measured in terms of the number. Suppose Th > 0 then individual h must pay tax of Th of good 1.
There is difference between holding and initial holding of good.
If the stock is available, then holding of good 1 will get automatically reduced. Suppose,

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Sometimes, individual pay tax after selling of some of his holding of other goods. Suppose Th < 0, then
he receives lump sum subsidy by holding his good 1. Such goods allowed to get increased.
If we assume that such phenomena of subsidy is exists then the lump sum transfers are written as
follows:

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Where,
Rh: Individual’s full income at the original initial holdings.
Now we can modify the above function as follows:

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The lump sum transfer approach is equivalent to redistribution of initial holding of all goods and
shares. If we assume that equation 83 or equation 84 is holding the same value. Therefore the value of
h’s has full income in terms of a number. Such number is equivalent to the cost of the Pareto efficient
commodity bundle xh* at the prices.
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Suppose h is maximized uh(xh) then it is subject to budget constraints that is p xh ≤ Rh. Individual
would set his/her marginal rate of substitution between commodity i and 1 which is equal to the
relative price pi. His/her demand for good i at relative prices P would be equal to the amount of good
i. Therefore individual receives A* as the Pareto efficient allocation.
Suppose firm j face the relative prices p and it would choose to produce yj*output. It will produce
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optimal quantity to maximize profit. Therefore Pareto efficiency required that firm to have marginal
rate of transformation. The marginal rate of technical substitution and marginal products are equal to
the relative commodity prices. The relative prices of pi are equal to the consumer’s marginal rates of
substitution at the Pareto efficient commodity bundles. The profit of the firm pyj is maximized at the
Pareto efficient output yj*.
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The relative prices are the basis for demand and supply of goods. Such relative prices are identical to
the required Pareto efficient allocation which we have defined at A*. The supply and demand
decisions are based on relative prices p and they are compatible. In the market economy, the
equilibrium is based on relative price p. it is a suitable choice of endowment. It achieves the desired
Pareto efficient allocation and it is the equilibrium price in competitive economy.
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Criticism:
(i) Incomplete and Uncompetitive Markets: We know that in real world market are neither
competitive nor complete. We specified in the above paragraph that the redistribution of the initial
endowments and allow market to do allocate resources efficiently. It is desired to have efficient
allocation. Suppose a firm produces output based on the prices in the market. It uses prices as
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parameter for production. But it is invalid if the firm has monopoly power. Most of the time firm
realizes that prices are affected by the production decisions. There are charges in production function
and demand. The supply play important role than only prices.
(ii) Convex Technology: The preferences and technology for a firm are non-convex. The relative
prices p* does not support the desired efficient allocation. It is expected in a competitive economy.
(iii) Redistribution: It may not be possible to make the kind of initial redistributions required for this
theorem. It is essential that the redistributions are lump sum. The individuals may not able to alter the
amounts paid or received. The taxes which should not affect their behavior at the margin otherwise it
will play reverse role.

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If it is possible for an individual to alter the amount paid or received under the distribution by
changing their demands or supplies. The effective prices individuals face are not the market prices
and will differ across individuals. If prices do not adjust to the same set of relative prices then
efficiency conditions will be violated.
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not affected by decisions taken by the individuals. In a more complete model, such decisions would
be endogenous. Individuals could accumulate shares by saving and alter their endowments by
investment in human capital to raise their skill levels.
Redistribution from individuals with large shareholdings or valuable initial endowments is
effectively a tax on saving or human investment. It is no longer a lump-sum tax. The relative prices
the individuals face would then vary depending on their shareholdings or skill levels and also across

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individuals.
(iv) Individual Abilities: We have seen that individuals save money and buy shares of firm. The
profit earned from shares is invested to enhance human skills and capabilities. But redistribution
from individual’s at large shareholding or initial endowments leads to problem. It effects on human
development and skills. There is no longer a lump-sum tax. It also means that at relative prices the
individuals face the prices which are depending on skills or share holdings. It is different for different
individuals.
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