Unit 3 Business Economics PYQ’s 17th Oct 2020 Shift 1

The correct answer is – Binding constraint in the production process

In the Leontief production function. L is considered a Binding constraint in the production process

Key Takeaways

1. The Leontief Production Function (LPF), named for the father of Input-Output economics Wassily Leontief. It is also known as the Fixed-Proportions Production Function. We still see the output (Q) being a function of capital (K) and labor (L). The designation of min refers to the smallest numbers for K and L.
2. The isoquants in the LPF are right angles.
3. In economics, the Leontief production function or fixed proportions production function is a production function that implies the factors of production will be used in fixed (technologically pre-determined) proportions, as there is no substitutability between factors. It was named after Wassily Leontief and represents a limiting case of the constant elasticity of substitution production function.

Additional Notes

A binding constraint is one where some optimal solution is on the line for the constraint. Thus if this constraint were to be changed slightly (in a certain direction), this optimal solution would no longer be feasible. A non-binding constraint is one where no optimal solution is on the line for the constraint.

The correct answer is – Satisfying behaviour

‘Constraint Optimisation’ is closer to the Satisfying behavior of business firms.

Key Takeaways

1. In mathematical optimization, constrained optimization is the process of optimizing an objective function with respect to some variables in the presence of constraints on those variables.
2. The objective function is either a cost function or energy function, which is to be minimized, or a reward function or utility function, which is to be maximized.
3. Constraints can be either hard constraints, which set conditions for the variables that are required to be satisfied, or soft constraints, which have some variable values that are penalized in the objective function if, and based on the extent that, the conditions on the variables are not satisfied.

The correct answer is – Skimming

Price skimming is a product pricing strategy by which a firm charges the highest initial price that customers will pay and then lowers it over time.

Key Takeaways

As the demand of the first customers is satisfied and competition enters the market, the firm lowers the price to attract another, a more price-sensitive segment of the population.

This approach contrasts with the penetration pricing model, which focuses on releasing a lower-priced product to grab as much market share as possible.

Additional Notes

1. Penetration pricing is a marketing strategy used by businesses to attract customers to a new product or service by offering a lower price during its initial offering. The lower price helps a new product or service penetrate the market and attract customers away from competitors

2. The Peak Load Pricing is the pricing strategy wherein the high price is charged for the goods and services during times when their demand is at peak. The consumer who purchases the commodity during the high demand period has to pay more as compared to the one who buys during low demand periods.

3. Dumping is a term used in the context of international trade. It’s when a country or company exports a product at a price that is lower in the foreign importing market than the price in the exporter’s domestic market.

The correct answer is – Product improvement

In a rising consumer income scenario, the preferred decision choice of business firms for low-income elastic products will be Product improvement.

Key Takeaways

Product improvement is the process of making meaningful product changes that result in new customers or increased benefits realized by existing customers. The two most popular ways to make product improvements are to add new product features or improve existing ones.

Additional Notes

1. Product Promotion means disseminating information about the product, product line, brand, and company to the prospective buyers with the intent to generate sales and develop brand loyalty. Promotion is the fourth element of the marketing mix.

2. Cost control is the practice of identifying and reducing business expenses to increase profits, and it starts with the budgeting process

3. Product repositioning is changing the overall positioning (that is, key product benefits, product use, or competitive advantages) or changing the target market for the product. In some cases, the product repositioning may coexist with a product improvement, or other times an existing product without change (except for packaging perhaps), will have a new image or target market constructed for it.

The correct answer is – Increasing returns

Increasing returns to scale indicates the above production function

Key Takeaways

In economics and econometrics, the Cobb–Douglas production function is a particular functional form of the production function, widely used to represent the technological relationship between the amounts of two or more inputs (particularly physical capital and labor) and the amount of output that can be produced by those inputs.

The Cobb–Douglas form was developed and tested against statistical evidence by Charles Cobb and Paul Douglas during 1927–1947.

Important Note

In its most standard form for production of a single good with two factors, the function is Y=AK^αL^β

where:

• Y = total production (the real value of all goods produced in a year or 365.25 days)
• L = labor input (person-hours worked in a year or 365.25 days)
• K = capital input (a measure of all machinery, equipment, and buildings; the value of capital input divided by the price of capital)
• A = total factor productivity
• α and β are the output elasticities of capital and labor, respectively. These values are constants determined by available technology.

Key Takeaways

1. If α + β = 1 you can say that the returns to scale are constant. It means that doubling the amount of both capital and labor would result in double the output.
2. If α + β < 1 returns to scale are decreasing. The proportional change in factors will result in a smaller proportional change in output.
3. If α + β > 1 returns to scale are increasing. Likewise, the proportional change in factors will lead to a higher proportional change in output.

The correct answer is – (C) and (E) only

Price discrimination is a selling strategy that charges customers different prices for the same product or service based on what the seller thinks they can get the customer to agree to.

Key Takeaways

There are three types of price discrimination: first-degree or perfect price discrimination, second-degree, and third-degree. These degrees of price discrimination are also known as personalized pricing (1st-degree pricing), product versioning or menu pricing (2nd-degree pricing), and group pricing (3rd-degree pricing).

1. First-degree Price Discrimination

• First-degree discrimination, or perfect price discrimination, occurs when a business charges the maximum possible price for each unit consumed.
• Because prices vary among units, the firm captures all available consumer surplus for itself or the economic surplus.
• Many industries involving client services practice first-degree price discrimination, where a company charges a different price for every good or service sold.

2. Second-degree Price Discrimination

• Second-degree price discrimination occurs when a company charges a different price for different quantities consumed, such as quantity discounts on bulk purchases.

3. Third-degree Price Discrimination

• Third-degree price discrimination occurs when a company charges a different price to different consumer groups.
• For example, a theater may divide moviegoers into seniors, adults, and children, each paying a different price when seeing the same movie.
• This discrimination is the most common.
• Third-degree price discrimination is sometimes known as direct price discrimination. Because a firm directly sets different prices depending on distinct groups of consumers (e.g. age)
• If you buy on the day, tickets are usually more expensive. If you book 7 days in advance and stick to a specific time of the day, the price is lower.
• On the same train, customers can be paying different prices for the same ticket.
• Charging different prices for the same product in different markets until the MR of the last unit sold equals the MC of the product sold in each market is described by Price discrimination of third-degree.

4. Equilibrium price

• On a graph, the point where the supply curve (S) and the demand curve (D) intersect is the equilibrium. The equilibrium price is the only price where the desires of consumers and the desires of producers agree—that is, where the amount of the product that consumers want to buy (quantity demanded) is equal to the amount producers want to sell (quantity supplied).

Therefore, charging different prices for the same product in different markets until the MR of the last unit sold equals the MC of the product sold in each market is described by Price discrimination of third-degree and Price discrimination.

The correct answer is – (B) and (D) only

Indifference Curve:

• An indifference curve shows a combination of two goods that give a consumer equal satisfaction and utility thereby making the consumer indifferent.
• Along the curve, the consumer has an equal preference for the combinations of goods shown—i.e. is indifferent about any combination of goods on the curve.
• Typically, indifference curves are shown convex to the origin, and no two indifference curves ever intersect.

Important Note

1. Indifference curves slope downward because, if the utility is to remain the same at all points along the curve, a reduction in the quantity of the good on the vertical axis must be counterbalanced by an increase in the quantity of the good on the horizontal axis (or vice versa).

1. Thus, the slope of the indifference curve is called the marginal rate of substitution, which declines as the quantity of X increases relative to the quantity of Y.

Here is an example to understand the indifference curve better. Peter has 1 unit of food and 12 units of clothing. Now, we ask Peter how many units of clothing is he willing to give up in exchange for an additional unit of food so that his level of satisfaction remains unchanged.

Peter agrees to give up 6 units of clothing for an additional unit of food. Hence, we have two combinations of food and clothing giving equal satisfaction to Peter as follows:

1. 1 unit of food and 12 units of clothing
2. 2 units of food and 6 units of clothing

By asking him similar questions, we get various combinations as follows:

Graphical Representation:

• Another reason for the declining slope of the indifference curve is the ordinal measurement of utilities.
• The concept of ordinal utility implies that the consumer cannot go beyond stating his preference or indifference.
• In other words, if a consumer prefers X to Y, he can not tell by ‘how much’ he prefers X to Y.
• The consumer cannot state the ‘quantitative differences’ between various levels of satisfaction; he can simply compare them ‘qualitatively’, that is, he can merely judge whether one level of satisfaction is higher than, lower than, or equal to another.

Thus, option 2 is the correct answer.

The correct answer is – (A), (B), (D) and (E) only

The term “economic man” (also referred to as “homo economicus”) refers to an idealized person who acts rationally, with perfect knowledge, and who seeks to maximize personal utility or satisfaction.

Key Takeaways

Consumer rationality in business economics is a collective manifestation of the following assumptions:

1. Non-Satiation: The assumption that a consumer will always benefit from additional consumption. The demand for some goods may have a finite limit, but it is likely that there is some good or service a consumer would benefit from having more of.

1. Clarity Of Preferences: This assumption states that, logically, selections between goods are rational because of the transitivity statement, which posits that people always prefer goods in the following order: A is preferred to B, and B is preferred to C, so A is preferred to C.

1. Economic Selfish Motive: The notion that human behavior is governed by selfishness as an ultimate motive – without altruism (selflessness) and group selection.

1. Possession Of Information: The assumption states that a consumer has perfect and complete information and he makes choices based on this information.

Divisibility Of Goods And Services is not an assumption of consumer rationality. Thus, option 4 is the correct answer.

The correct answer is – (A), (B) and (C) only

Price discrimination is a selling strategy that charges customers different prices for the same product or service based on what the seller thinks they can get the customer to agree to.

Key Takeaways

Conditions necessary for price discrimination:

1. Firm must have some monopoly power:

• First, the market must be a form of imperfect competition.
• If there was a perfect competition then price discrimination would be not possible as a producer would not be able to control their prices.
• There must be some level of monopoly power to allow producers the ability to be price-maker and not price-taker.
• For example, Nurofen created higher prices on the same painkiller which had the same result. This was able to occur as there was asymmetric information among consumers and some monopoly power of Nurofen.

2. A key condition for price discrimination to occur is the identification of different market segments.

3. This is because different groups have different price elasticities of demand.

Therefore the firm can charge different prices depending on the consumer’s sensitivity to price changes. For example, they could charge higher for richer, inelastic consumers who continue buying no matter how much the price rises. The firm continues to gain profit as long as the marginal revenue is greater than marginal cost.

Thus, option 4 is the correct answer.

Additional Notes

Free entry and exit of firms is a characteristic of perfect competition. The producer is not able to control the prices in a perfectly competitive market. The producer is a price-taker. Thus, price discrimination won’t be possible.

The correct answer is – A – III, B – IV, C – II, D – I

There are different types of market structures that characterize an economy and it refers to the degree of market structure in an economy. There are other determinants of market structure such as the nature of the products, the number of buyers and sellers, economy scale, etc.

There are four basic types of market structure:

1. Perfect Competition
2. Monopoly
3. Monopolistic Competition
4. Oligopoly

Key Takeaways

Therefore, it is clear from the above explanation that option 3) is the correct answer.

The correct answer is – (C), (B), (D) and (A)

Price elasticity of demand is an economic measure of the change in the quantity demanded or purchased of a product in relation to its price change.

Expressed mathematically, it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price.

Key Takeaways

The following products in the increasing order of price elasticities:

1. Normal goods/ Necessities

• whose income elasticity of demand is between zero and one are typically referred to as necessary goods, which are products and services that consumers will buy regardless of changes in their income levels.
• Examples of necessary goods and services include tobacco products, haircuts, water, and electricity

2. Product differentiation

• It is the process of distinguishing a product or service from others.
• This involves detailing the characteristics that are valued by customers that make it unique.
• When utilized successfully, product differentiation creates a competitive advantage as customers view your product as superior.

1. Durable goods:
   • A durable good or a hard good or consumer durable is a good that does not quickly wear out, or more specifically, one that yields utility over time rather than being completely consumed in one use.
   • Items like bricks could be considered perfectly durable goods because they should theoretically never wear out.
   • Highly durable goods such as refrigerators or cars usually continue to be useful for three or more years of use, so durable goods are typically characterized by long periods between successive purchases.
   • The elasticity of demand for durable goods is greater than unity.

4. Homogenous products

• Products are considered to be homogenous when they are perfect substitutes and buyers perceive no actual or real differences between the products offered by different firms.
• Price is the single most important dimension along which firms producing homogenous products compete.

Therefore, option 1 is the right answer.