Fundamentals of Economics 1

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Assignment A

Q1. What is price discrimination? Under what necessary conditions can price discrimination be practiced?

Q2. Explain the concept of consumer’s surplus. How is it related to utility?

Q3. Distinguish between factors causing movement and shift in the supply curve.

Q4. Explain Marginal productivity theory.

Q5 .What are the major sources of disequilibrium in the BOP of the country? What kind of BOP disequilibrium can hardly be cured through policy measures?

 

Assignment B

Three Subjective Questions + Case Study

Q1. Explain the Sweezy’s kinked demand curve model of Oligiopoly . How does it explain price rigidity under oligopoly?

Q2 . What are the arguments against the fixed exchange rate ? Why does the IMF want the member nations to adopt a fixed exchange rate policy despite its advantages?

Q3 Distinguish between laws of returns to variable proportions and laws of returns to scale. Explain the factor, which cause increasing returns to scale.

 

Case Study

An Oil Crisis Provoked Policy Dilemma

The sudden increase in the price of crude oil by the OPEC countries has put India in a fix. To top it, the Finance Ministry which had increased the market price of LPG and SKO (kerosene) had to partially roll it back, the former by Rs 10 and the latter by Re 1 under political pressure. This means the burden on the Union Budget has increased on both grounds, one because of an increase in the oil price internationally and second, because of the subsidy on petroleum products. All of these will result in an additional burden of Rs 560 crore, a burden which is unbearable, given the present situation of the Central Government’s deficit. The fiscal deficit stands at a figure of 5.6 per cent as against the target of 4.5 per cent. The situation by all standards is alarming. Some suggested that a temporary cut should be made in the import of crude oil, but this is a straight invitation to a supply shock inflation, such that not only the prices in the economy go up, but there is a shortfall in the supply of various products including LPG, SKO, HSD (diesel), etc., a situation totally avoidable by all means.

A more plausible argument was put forward by some other people in the Finance Ministry, that of restructuring so that more emphasis is laid automatic stabilizers, various direct taxes like income tax, corporate tax, etc. The argument that was put forward was, the industry was out of recession and corporate income seemed to be on a pick. The export sector was also booming with a growth rate of 15 per cent. All these have a positive impact on the GDP growth rate (though the agricultural sector seemed to be pulling along without much growth in the services sector). The GDP at market price seemed to grow at an impressive rate of 7 per cent (whereas the GDP at factor cost was growing only at 6.25 per cent). All these make the industrial as well as the external sector, a good source of taxation; Ministry officials further said, in the face of a surging fiscal deficit, mainly due to interest repayment, the burden of government-increased taxation seems inevitable, and one is lucky that at least two sectors are doing well.

 

However, the officials seem to have missed one point: a direct tax like income or corporate tax, which moves proportionally with the rising income has a dampening effect on not only the overall industrial and corporate atmosphere, but the total effect is a multiple of the initial tax burden as it affects the investment multiplier value negatively. Taxing the export sector also creates a negative multiplier effect. People from the ministry seem to face a real dilemma. An increase in such proportional direct taxes make them instantaneously richer by Rs 9,000 to12,000 crore, but there is a risk of putting the country back on yet another industrial slowdown. However, allowing further deficit in the budget is also by no means desirable.

Questions

  1. Discuss the kind of inflation the country might face if there is a shortage of crude oil in the economy.
  2. How does a direct proportional tax have a negative multiplier effect on the economy’s level of income?