1. Que 1. Distinguish between a firm and an industry. Explain the equilibrium of a firm
and industry under perfect competition.
Answer:-
Distinguish between a firm and an industry
An industry is the name given to a certain type of manufacturing or retailing environment.
 For example, the retail industry is the industry that involves everything from clothes
to computers, anything in the shops that get sold to the public. The retail industry is
very vast and has many sub divisions, such as electrical and cosmetics. More
specialized industries deal with a specific thing. The steel industry is a more specialized
industry, dealing with the making of steel and selling it on to buyers.
 The difference between this and a firm is that a firm is the company that operates
within the industry to create the product. The firm might be a factory, or the chain of
stores that sells the clothes, within its industry. For example, one firm that makes steel
might be Aveda steel. They create the steel in that firm for the steel industry.
A firm is usually a corporate company that controls a number of chains in the industry it is
operating within.
 For example in retail, the firm Arcadia stores own the clothing chains Top shop,
Dorothy Perkins, Miss Selfridge, and Evans. These all operate for the firm Arcadia
within the industry of retail.
 Several firms can operate in one industry to ensure that there is always competition to
keep prices reasonable and stop the market becoming a monopoly, which is where one
firm is in charge of the whole industry. Sometimes, a firm is not necessary within the
industry and independent chains and retailers can enter straight into the market
without a firm behind them, although this is risky.
 This is because one of the advantages of having a firm behind you is that it is a
safeguard against possible bankruptcy because the firm can support the chain that it
owns.
The equilibrium of a firm and industry under perfect competition
According to Miller, “Firm is an organization that buys and hires resources and sells goods and
services”. Lipsey has defined as “firm is the unit that employs factors of production to produce
commodities that it sells to other firms, to households, or to the government.”
 Industry is a group of firms producing standardized products in a market. According to
Lipsey, “Industry is a group of firms that sells a well defined product or closely related
set of products.”

2. Conditions of Equilibrium of the Firm and Industry
A firm is in equilibrium when it has no propensity to modify its level of productivity. It requires
neither extension nor retrenchment. It wants to earn maximum profits in by equating its
marginal cost with its marginal revenue, i.e. MC = MR. Diagrammatically, the conditions of
equilibrium of the firm are
(1) the MC curve must equal the MR curve.
This is the first order and essential condition. But this is not a sufficient condition which may
be fulfilled yet the firm may not be in equilibrium.
(2) The MC curve must cut the MR curve from below and after the point of equilibrium it
must be above the MR.
This is the second order condition. Under conditions of perfect competition, the MR curve of a
firm overlaps with the AR curve. The MR curve is parallel to the X axis. Hence the firm is in
equilibrium when MC = MR = AR.
The first order figure (1), the MC curve cuts the MR curve first at point X. It contends the
condition of MC = MR, but it is not a point of maximum profits for the reason that after point
X, the MC curve is beneath the MR curve.
It does not pay the firm to produce the minimum output OM when it can earn huge profits by
producing beyond OM. Point Y is of maximum profits where both the situations are fulfilled.
Amidst points X and Y it pays the firm to enlarges its productivity for the reason that it’s MR >
MC.
It will nevertheless stop additional production when it reaches the OM1 level of productivity
where the firm fulfils both the circumstances of equilibrium. If it has any plants to produce
more than OM1 it will be incurring losses, for its marginal cost exceeds its marginal revenue
beyond the equilibrium point Y. The same finale hold good in the case of straight line MC
curve and it is presented in the figure.

3. An industry is in equilibrium, first when there is no propensity for the firms either to leave or
either the industry and next, when each firm is also in equilibrium. The first clause entails that
the average cost curves overlap with the average revenue curves of all the firms in the
industry.
They are earning only normal profits, which are believed to be incorporated in the average
cost curves of the firms. The second condition entails the equality of MC and MR. Under a
perfectly competitive industry these two circumstances must be fulfilled at the point of
equilibrium
i.e. MC = MR….
(1), AC = AR….
(2), AR = MR.
Hence MC = AC = AR. Such a position represents full equilibrium of the industry.
Short Run Equilibrium of the Firm and Industry
1. Short Run Equilibrium of the Firm
A firm is in equilibrium in the short run when it has no propensity to enlarge or contract its
productivity and needs to earn maximum profit or to incur minimum losses.
 The short run is an epoch of time in which the firm can vary its productivity by
changing the erratic factors of production. The number of firms in the industry is fixed
since neither the existing firms can leave nor new firms can enter it.
Postulations
• All firms use standardised factors of production
• Firms are of diverse competence
• Cost curves of firms are dissimilar from each other
• All firms sell their produces at the equal price ascertained by demand and supply of
the industry so that the price of each firm, P (Price) = AR = MR

4. • Firms produce and sell various volumes
• The short run equilibrium of the firm can be described with the helps of marginal study
and total cost revenue study.
Marginal Cost, Marginal Revenue analysis – During the short run, a firm will produce only its
price equals average variable cost or is higher than the average variable cost (AVC).
 Furthermore, if the price is more than the averages total costs, ATC, i.e. P = AR > ATC
the firm will be earning super normal profits. If price equals the average total costs,
i.e. P = AR = ATC the firm will be earning normal profits or break even.
 If price equals AVC, the firm will be incurring losses. If price drops even a little below
AVC, the firm will shut down since in order to produce it must cover atleast it’s AVC
through short run. So during the short run, under perfect competition, affirm is in
equilibrium in all the above mentioned stipulations.
 Super normal profits – The firm will be earning super normal profits in the short run
when price is higher than the short run average cost.
 Normal Profits = The firm may earn normal profits when price equals the short run
average costs.
 Total Cost – Total Revenue Analysis – The short run equilibrium of the firm can also be
represented with the help of total cost and total revenue curves. The firm is able to
maximise its profits when the positive discrimination between TR and TC is the
greatest.
1. Short Run Equilibrium of the Industry
An industry is in equilibrium in the short run when its total output remains steady there being
no propensity to enlarge or contract its productivity. If all firms are in equilibrium the industry
is also in equilibrium. For full equilibrium of the industry in the short run all firms must be
earning normal profits.
 But full equilibrium of the industry is by sheer accident for the reason that in the short
rum some firms may be earning super normal profits and some losses. Even then the
industry is in short run equilibrium when its quantity demanded and quantity supplied
is equal at the price which clears the market.
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6. Que 2. Give a brief description of:
a. Implicit and explicit cost
b. Actual and opportunity cost
Answer.
a. Implicit and explicit cost
 Implicit cost
In economics, an implicit cost, also called an imputed cost, implied cost, or notional cost, is
the opportunity cost equal to what a firm must give up in order using factors which it neither
purchases nor hires. It is the opposite of an explicit cost, which is borne directly.
 In other words, an implicit cost is any cost that results from using an asset instead of
renting, selling, or lending it. The term also applies to forgone income from choosing
not to work.
 Implicit costs also represent the divergence between economic profit (total revenues
minus total costs, where total costs are the sum of implicit and explicit costs)
and accounting profit (total revenues minus only explicit costs). Since economic profit
includes these extra opportunity costs, it will always be less than or equal to
accounting profit
 Explicit cost
An explicit cost is a direct payment made to others in the course of running a business, such
as wage, rent and materials, as opposed to implicit costs, which are those where no actual
payment is made.
 It is possible still to underestimate these costs, however: for example, pension
contributions and other "perks" must be taken into account when considering the cost
of labour.
 Explicit costs are taken into account along with implicit ones when
considering economic profit. Accounting profit only takes explicit costs into account.
b. Actual and opportunity cost
 Actual cost
An actual amount paid or incurred, as opposed to estimated cost or standard cost. In
contracting, actual costs amount includes direct labor, direct material, and other
direct charges.

7.  Cost accounting information is designed for managers. Since managers are taking
decisions only for their own organization, there is no need for the information to be
comparable to similar information from other organizations. Instead, the important
criterion is that the information must be relevant for decisions that managers
operating in a particular environment of business including strategy make.
 Cost accounting information is commonly used in financial accounting information, but
first we are concentrating in its use by managers to take decisions. The accountants
who handle the cost accounting information generate add value by providing good
information to managers who are taking decisions.
 Among the better decisions, the better performance of one's organization, regardless if
it is a manufacturing company, a bank, a non-profit organization,
a government agency, a school club or even a business school. The cost-accounting
system is the result of decisions made by managers of an organization and the
environment in which they make them.
 Opportunity cost
Opportunity cost is the cost of any activity measured in terms of the value of the next best
alternative forgone (that is not chosen).
 It is the sacrifice related to the second best choice available to someone, or group,
who has picked among several mutually exclusive choices. The opportunity cost is also
the cost of the forgone products after making a choice.
 Opportunity cost is a key concept in economics, and has been described as expressing
"the basic relationship between scarcity and choice". The notion of opportunity cost
plays a crucial part in ensuring that scarce resources are used efficiently.
 Thus, opportunity costs are not restricted to monetary or financial costs: the real
cost of output forgone, lost time, pleasure or any other benefit that
provides utility should also be considered opportunity costs.
 Opportunity costs in production
Opportunity costs may be assessed in the decision-making process of production. If the
workers on a farm can produce either one million pounds of wheat or two million pounds of
barley, then the opportunity cost of producing one pound of wheat is the two pounds of barley
forgone (assuming the production possibilities frontier is linear). Firms would make rational
decisions by weighing the sacrifices involved.

8. Que 3. A firm supplied 3000 pens at the rate of Rs 10. Next month, due to a rise of
in the price to 22 Rs. per pen the supply of the firm increases to 5000 pens. Find the
elasticity of supply of the pens.
Answer.
Of course, consumption is not the only thing that changes when prices go up or down.
Businesses also respond to price in their decisions about how much to produce.
 Economists define the price elasticity of supply as the responsiveness of the
quantity supplied of a good to its market price.
 More precisely, the price elasticity of supply is the percentage change in quantity
supplied divided by the percentage change in price.
 Suppose the amount supplied is completely fixed, as in the case of perishable pen
brought to market to be sold at whatever price they will fetch. This is the limiting case
of zero elasticity, or completely inelastic supply, which is a vertical supply curve.
At the other extreme, say that a tiny cut in price will cause the amount supplied to fall to
zero, while the slightest rise in price will coax out an indefinitely large supply. Here, the ratio
of the percentage change in quantity supplied to percentage change in price is extremely
large and gives rise to a horizontal supply curve. This is because the polar case of infinitely
elastic supply.
 Between these extremes, we call elastic or inelastic depending upon whether the
percentage change in quantity is larger or smaller than the percentage change in price.
Price elasticity of demand is a ratio of two pure numbers, the numerator is the
percentage change in the quantity demanded and the denominator is the percentage
change in price of the commodity. It is measured by the following formula:
Ep =
Percentage change in quantity demanded/ Percentage changed in price Applying the provided
data in the equation:
Percentage change in quantity demanded
= (5000 – 3000)/3000Percentage changed in price
= (22 – 10) / 10
Ep = ((5000 – 3000)/3000) / ((22 – 10)/10)
= 1.2.

9. Que 4. What is monetary policy?
Explain the general objectives and instruments of monetary policy?
Answer:
Monetary Policy
Monetary policy, in its narrow concept, is defined as the measures focused on regulating
money supply. In harmony with monetary policy goals, as will be shown later, and adopting
the most common concept of monetary policy as one of the central bank’s functions
 Monetary policy is defined as “ the set of procedures and measures taken by monetary
authorities to manage money supply, interest and exchange rates and to influence
credit conditions to achieve certain economic objectives”.
 We find this definition more consistent with the practical applications of monetary
policy, particularly with respect to the difference from one country to another in
objectives selected as a link between the instruments of monetary policy and its
ultimate goals.
First: Monetary Policy and General Economic Policies
Monetary policy is basically a type of stabilization policy adopted by countries to deal with
different economic imbalances. Since monetary policy covers the monetary aspect of the
general economic policy, a high level of co-ordination is required between monetary policy and
other instruments of economic policy.
 Further, the effectiveness of monetary policy and its relative importance as a tool of
economic stabilization various from one economy to another, due to differences among
economic structures, divergence in degrees of development in money and capital
markets resulting in differing degree of economic progress, and differences in
prevailing economic conditions.
 However, we may briefly mention that the weak effectiveness which is usually
attributed to monetary policy in developing countries is caused by the fact that the
economic problems in these countries are mainly structural and not monetary in
nature, while the limited effectiveness of monetary policy in countries which lack
developed money markets occurs because monetary policy is deprived of one of its
major tools, the instrument of open market operations.
 Also, there are those who belittle the effectiveness of monetary policy in time of
recession, comparing the use of this policy in controlling recession as “pressing on a
spring”.
 Many others see monetary policy as ineffective in controlling the inflation that results
from an imbalance between the demand and supply of goods and services originating

10. from the supply side, while they confirm the effectiveness of monetary policy in
controlling inflation that results from increased demand.
 However, this does not preclude the effectiveness of monetary policy as a flexible
instrument allowing the authorities to move quickly to achieve stabilization, apart from
its importance in realizing external equilibrium in open economies.
Monetary Policy Instruments
The set of instruments available to monetary authorities may differ from one country to
another, according to differences in political systems, economic structures, statutory and
institutional procedures, development of money and capital markets and other considerations.
In most advanced capitalist countries, monetary authorities use one or more of the following
 key instruments: changes in the legal reserve ratio, changes in the discount rate or the
official key bank rate, exchange rates and open market operations.
 In many instances, supplementary instruments are used, known as instruments of
direct supervision or qualitative instruments. Although the developing countries use
one or more of these instruments, taking into consideration the difference in their
economic growth levels, the dissimilarity in the patterns of their production structures
and the degree of their of their link with the outside world, many resort to the method
of qualitative supervision, particularly those countries which face problems arising from
the nature of their economic structures.
 Although the effectiveness of monetary policy does not necessarily depend on using a
wide range of instruments, coordinated use of various instruments is essential to the
application of a rational monetary policy.

11. Que 5. Explain in brief the relationship between TR, AR, and MR under different
market condition.
Answer:
Meaning and Different Types of Revenues
Revenue is the income received by the firm. There are three concepts of revenue –
1. Total revenue (T.R)
2. Average revenue (A.R)
3. Marginal revenue (M.R)
1. Total revenue (TR):
Total revenue refers to the total amount of money that the firm receives from the sale of its
products, i.e. .gross revenue.
 In other words, it is the total sales receipts earned from the sale of its total output
produced over a given period of time.
 In brief, it refers to the total sales proceeds. It will vary with the firm’s output and
sales. We may show total revenue as a function of the total quantity sold at a given
price as below.
TR = f (q).
It implies that higher the sales, larger would be the TR and vice-versa.
 TR is calculated by multiplying the quantity sold by its price. Thus, TR = PXQ. For e.g.
a firm sells 5000 units of a commodity at the rate of Rs. 5 per unit, then TR would be

12. 2. Average revenue (AR)
Average revenue is the revenue per unit of the commodity sold. It can be obtained by dividing
the TR by the number of units sold.
Then, AR = TR/Q AR
= 150/15
= 10.
 When different units of a commodity are sold at the same price, in the market,
average revenue equals price at which the commodity is sold
 For e.g. 2 units are sold at the rate of Rs.10 per unit, then total revenue would be Rs.
20 (2×10).
Thus AR = TR/Q 20/2
= 10.
 Thus average revenue means price. Since the demand curve shows the relationship
between price and the quantity demanded, it also represents the average revenue or
price at which the various amounts of a commodity are sold, because the price offered
by the buyer is the revenue from seller’s point of view.
 Therefore, average revenue curve of the firm is the same as demand curve of the
consumer.
Therefore, in economics we use AR and price as synonymous except in the context of price
discrimination by the seller. Mathematically P = AR.
3. Marginal Revenue (MR)
Marginal revenue is the net increase in total revenue realized from selling one more unit of a
product.
 It is the additional revenue earned by selling an additional unit of output by the seller.
MR differs from the price of the product because it takes into account the effect of changes in
price.
 For example if a firm can sell 10 units at Rs.20 each or 11 units at Rs.19 each, then
the marginal revenue from the eleventh unit is
(10 × 20) - (11 × 19)
= Rs.9.

13. Relationship between Total revenue, Average revenue and Marginal Revenue
concepts
In order to understand the relationship between TR, AR and MR, we can prepare a
hypothetical revenue schedule.
From the table, it is clear that:
 MR falls as more units are sold.
 TR increases as more units are sold but at a diminishing rate.TR is the highest when
MR is zero
 TR falls when MR become negative
 AR and MR both falls, but fall in MR is greater than AR i.e., MR falls more steeply than
AR.
Relationship between AR and MR and the nature of AR and MR curves under
difference market conditions
1. Under Perfect Market
Under perfect competition, an individual firm by its own action cannot influence the market
price. The market price is determined by the interaction between demand and supply forces.
 A firm can sell any amount of goods at the existing market prices. Hence, the TR of the
firm would increase proportionately with the output offered for sale. When the total
revenue increases in direct proportion to the sale of output, the AR would remain
constant.
 Since the market price of it is constant without any variation due to changes in the
units sold by the individual firm, the extra output would fetch proportionate increase in
the revenue.
 Hence,MR & AR will be equal to each other and remain constant. This will be equal to
price.

14. Under perfect market condition, the AR curve will be a horizontal straight line and parallel to
OX axis. This is because a firm has to sell its product at the constant existing market price.
The MR cure also coincides with the AR curve. This is because additional units are sold at the
same constant price in the market.
2. under Imperfect Market
Under all forms of imperfect markets, the relation between TR, AR, and MR is different. This
can be understood with the help of the following imaginary revenue schedule.
From the above table it is clear that:
 In order to increase the sales, a firm is reducing its price, hence AR falls

15.  As a result of fall in price, TR increase but at a diminishing rate
 TR will be higher when MR is zero
 TR falls when MR becomes negative
From the above table it is clear that:
 In order to increase the sales, a firm is reducing its price, hence AR falls.
 As a result of fall in price, TR increase but at a diminishing rate.
 TR will be higher when MR is zero
 TR falls when MR becomes negative
 AR and MR both declines. But fall in MR will be greater than the fall in AR.
The relationship between AR and MR curves is determined by the elasticity of
demand on the average revenue curve.
Under imperfect market, the AR curve of an individual firm slope downwards from left
to right. This is because; a firm can sell larger quantities only when it reduces the
price. Hence, AR curve has a negative slope.
 The MR curve is similar to that of the AR curve. But MR is less than AR. AR and
MR curves are different. Generally MR curve lies below the AR curve.
 The AR curve of the firm or the seller and the demand curve of the buyer is the same
Since, the demand curve represents graphically the quantities demanded by the
buyers at various prices it shows the AR at which the various amounts of the goods
that are sold by the seller.
 This is because the price paid by the buyer is the revenue for the seller (One man’s
expenditure is another man’s income). Hence, the AR curve of the firm is the same
thing as that of the demand curve of the consumers.
Suppose, a consumer buys 10 units of a product when the price per unit is Rs.5 per unit.
Hence, the total expenditure is 10 x 5 = Rs.50/-.
The seller is selling 10 units at the rate of Rs.5 per unit. Hence, his total income is
10 x 5 = Rs.50/-.
Thus, it is clear that AR curve and demand curve is really one and the same.

16. Que 6. What is a business cycle? Describe the different phases of a business cycle.
Answer:
The business cycle describes the phases of growth and decline in an economy. The goal
of economic policy is to keep the economy in a healthy growth rate fast enough to create jobs
for everyone who wants one, but slow enough to avoid inflation.
 Unfortunately, life is not so simple. Many factors can cause an economy to spin out of
control, or settle into depression. The most important, over-riding factor is confidence
of investors, consumers, businesses and politicians.
 The economy grows when there is confidence in the future and in policymakers, and
does the opposite when confidence drops.
The phase of the Business Cycle
There are four stages that describe the business cycle. At any point in time you are
in one of these stages:
1. Contraction - When the economy starts slowing down.
2. Trough - When the economy hits bottom, usually in a recession.
3. Expansion - When the economy starts growing again.
4. Peak - When the economy is in a state of "irrational exuberance."
Who Determines the Business Cycle Stages?
The National Bureau of Economic Research (NBER) analyzes economic indicators to determine
the phases of the business cycle. The Business Cycle Dating Committee uses quarterly GDP growth rates
as the primary indicator of economic activity.
 The Bureau also uses monthly figures, such as employment, real personal income,
industrial production and retail sales.
What GDP Can You Expect in Each Business Cycle Phase?
In the Contraction phase, GDP growth rates usually slow to the 1%-2% level before actually
turning negative.
 The 2008 recession was so nasty because the economy immediately shrank 1.8% in
the first quarter 2008, grew just 1.3% in the second quarter, before falling
another 3.9% in the third quarter, and then plummeting a whopping 8.9% in the
fourth quarter.

17.  The economy received another wallop in the first quarter of 2009, when the economy
contracted abrutal 6.9%.
Master of Business Administration- MBA Semester 1
MB0038 –Managerial Economics–
4 Credits
(Book ID:B1127)
Assignment Set- 1 (60 Marks)