NCERT TEXTBOOK QUESTIONS SOLVED
Question 1. What are the characteristics of a perfectly competitive market?
Ans. Perfect competition is defined as a market structure in which an individual firm cannot influence the prevailing market price of the product on its own. A good example of perfect competition is the agriculture market. Otherwise, it is an ideal situation which rarely exists in the real world. There said to be perfect competition in an industry when certain conditions are satisfied.
These conditions or assumptions are divided into two group:
(a) Conditions of pure competition among the producers,
plus (from 1, 2 and 3)
(b) Conditions of perfect market for the commodity.
(4, 5, 6 and 7)
Features of Perfect Competition:
The following are the main features of perfect competition:
- Large Number of Sellers and Buyers: The number of firms selling a particular commodity is so large that any increase or decrease in the supply of one particular firm hardly influences the total market supply. Accordingly,any individual firm fails to make any influence on the price of the commodity. Not only is the number of sellers very large, also the number of buyers is very large.Accordingly, like an individual firm, an individual buyer is also not able to influence price of the commodity. It is therefore said that a firm under perfect competition is a price taker. In other words, it has to sell its products at the prevailing market price.
- Implication: The perfectly competitive firm is then a ‘price-taker’ and can sell any amount of the commodity at the given price.
- Homogeneous Product: All sellers sell identical units of a given product. An important conclusion can be drawn from this feature. It is that buyers will have no reason to prefer the product of one seller to the product of another seller. Thus, the price of the product throughout the market will be the same.
Implication: since the products are identical, buyers are indifferent between suppliers.
- Free Entry and Exit of Firms: A firm can enter and leave any industry. There is no legal restriction on the entry or exit.
Implication: The implication of this feature is that given sufficient time, all firms in the industry will be earning just normal profit.
- Perfect Knowledge: Buyers and sellers are fully aware of the price prevailing in the market. Buyers know it fully well at what price sellers are selling a given product. As a consequence, only one price prevails in the market.
Implication: The implication of this feature is that any attempt by any firm to charge a price higher than the prevailing uniform price will fail. The buyers will not pay higher price because they have perfect knowledge.
- Perfect Mobility: Factors of production are perfectly mobile under perfect competition. Factor will move to
that industry which pays the highest remuneration.
Implication: Its implication is that skills can be learnt easily.
- No Extra Transport Cost: All goods are produced locally. Transportation costs are zero.
- No Selling costs: Selling homogeneous product at the given price rules out the possibility of advertisement or other sale-promotion expenses. So that there are no selling costs in perfectly competitive market.
Question 2. How are the total revenue of a firm, market price and the quantity sold by the competitive firm related to each other?
(iv) Revenue Curves under Perfectly Competitive Market or
Perfect Competition: Under perfect competition, a firm is only a price-taker. It can sell any number of units of output at the prevailing price. If a firm tries to sell at a price higher than the market price, it will lose its entire customer, because they are fully aware of market conditions. In other words, no firm under perfect competition can charge a price higher than the prevailing market price. Nor can it afford to charge a price less than the prevailing market price. Hence, its marginal revenue is equal to its average revenue (price). It is shown in the figure. The horizontal straight line represents both marginal as well as average revenue and price. Thus, firm’s AR and MR curves are perfectly elastic under perfect competition.
Question 3. What is the ‘price line’?
Ans. AR curve is called price line of the firm.
Question 4. Why is the total revenue curve of a price-taking firm an upward –sloping straight line? Why does the curve pass through the origin?
Ans. Let us explain each word.
Upward Sloping: TR curve is upward sloping because as quantity sold increases, TR of the firm also increases.Whenever there is positive correlation in two variable, we get an upward sloping curve.
Straight Line: TR is a straight line because its slope is constant. Slope of Total Revenue is Marginal Revenue. It is constant because price in perfect competition is given and constant. If AR is constant, by mathematical rules, MR will also be constant.
TR passes through Origin: Since at zero level of outputsold, TR is also zero, therefore it starts from origin.
Question 5. What is the relation between market price and average revenue of a price taking firm?
Ans. Market price is average revenue of the firm
i.e. Market Price = Average Revenue it can be shown as follows:
TR = Price × Quantity
AR = TR/Quantity
AR = Price × Quantity/Quantity
AR = Price
NOTE: AR is the price of the commodity if and only all units are being sold at the same price. If producer charges different price for different units of the product then AR will not be equal to the Price. But in real life we see that most of the times, (except for discriminating monopoly) a seller charges same price for all the units of a product and hence, AR is equal to price
Question 6. What is the relation between market price and marginal revenue of a price taking firm?
Ans. Market price is nothing but average revenue. However the relation between market price i.e. AR and MR varies market to market but a generalized relation is that:
(a) When Market price or AR is constant, MR and market price are equal.
(b) When Market price or AR falls, MR falls at a greater speed.
(c) When Market price or AR rises, MR rises at a greater speed.
Question 7. What conditions must hold if a profit-maximizing firm produces positive output in a competitive market?
Ans. Under perfect competition, a firm is in equilibrium in short-run when the following two conditions are fulfilled.
(i) MR = MC
(ii) MC cuts MR from below or MC is rising at the point of equilibrium. The given figure illustrates this situation.
In the diagram, MR = MC at two levels of output: Q and Q1. However, Q1 is not equilibrium level of output. Corresponding to point Q1 there is point E1 which, no doubt, indicates that MR = MC. However, MC is not rising here, rather it is falling. Therefore, second condition is not fulfilled here. Clearly E is the point where not only MR = MC, but MC is also rising. So Q is the equilibrium level of output.In short-run, when a producer or firm is in equilibrium
three situations are possible:
(i) Super Normal Profit, (ii) Normal Profit, (iii) Minimum Loss.
(i) Super Normal Profit (Super Normal Profit): Super normal profits occur to the firm when its AR > AC and both the conditions of equilibrium are also met. Therefore,in this case AR > AC, MR = MC and MC cuts MR from below.
In Fig. 2E is the point of equilibrium and corresponding to this Q is equilibrium level of output.Here, AR is EQ, AC is FQ and clearly AR > AC.p per unit = AR – AC = EQ – FQ = EF. Firm is producing GF output.
Total Super Normal Profit of the firm is GF × EF = EFGP
(ii) Normal Profit: Normal profits occur when AR = AC and both the conditions of equilibrium are also met.
Here, AR = EQ, AC = EQ p per unit = AR – AC = 0 as
AR = AC
Firm is in equilibrium when it produces OQ level of output and it is earning just normal profit.
Point E is also known as Break-even point as AR = AC
or TR = TC. The firm is just recovering its costs.
Normal profit is a part of total cost of the firm. It is equal to reward to the producer for his entrepreneurial services. This is included in the estimation of TC. Thus, when AR = AC and p = 0, it generally refers to the absence of super normal profit.
(iii) Minimum Loss: A firm incurs loss when its AR < AC
(or TR < TC) and still, the firm is in equilibrium.
In this figure, firm is in equilibrium at point E where not only MR = MC, but MC is also rising. OQ is equilibrium output. However, firm is incurring loss as:
AR = EQ
AC = FQ
Clearly, AR < AC, per unit Loss
= AR – AC
= EQ – FQ
= – EF
Total Loss = Loss per unit of output × Total output
= – EF × PE
= – EFGP
Question 8. Can there be a positive level of output that a profit maximizing firm produces in a competitive market price is not equal to marginal cost? Give an explanation.
Ans. No, there cannot be any positive level of output that a
profit-maximizing firm produces in a competitive market
price is not equal to marginal cost.If a firm is able to get its AVC, it can continue in a hope of recovering fixed cost in the long run but if a firm is not able to get even its marginal cost, it certainly is not recovering its variable cost even. In such a situation,by taking a decision to shut down it can minimize its loss.
In case it shut down losses = TFC
If it continues, Losses = TFC + that portion of TVC which is not covered. Therefore, being rational the firm must shut down.
Question 9. Will a profit-maximizing firm in a competitive market ever produce a positive level of output in the range where the marginal cost is falling? Give an explanation.
Ans. No, a profit-maximizing firm in a competitive market will never produce a positive level of output in the range where the marginal cost is falling if it has to maximize output but if it is choosing between shut down or to continue then it may produce if it is recovering its average variable cost.
Question 10. Will a profit-maximizing firm in a competitive market produce a positive level of output in the short run if the market price is less than the minimum of AVC? Give an explanation.
Ans. No, a profit-maximizing firm in a competitive market will not produce a positive level of output in the short run if the market price is less than the minimum of AVC If a firm is able to get its AVC, it can continue in a hope of recovering fixed cost in the long run but if a firm is not able to get even its marginal cost, it certainly is not recovering its variable cost even. In such a situation,by taking a decision to shut down it can minimize its loss.
In case it shuts down losses = TFC
If it continues, Losses = TFC + that portion of TVC which is not covered.
Therefore, being rational the firm must shut down.
Shut down point is a level where price is equal to AVC.
Shut Down Below AVC. If the price drops below the average variable cost, the firm is unable to cover even the variable cost and can reduce the loss by shutting down and paying only the fixed costs.
Question 11. Will a profit-maximizing firm in a competitive market produce a positive level of output in the long run if the market price is less than the minimum of AC? Give an explanation.
Ans. No, a profit-maximizing firm in a competitive market will not produce a positive level of output in the long run if the market price is less than the minimum of AC because in the long run all costs are variable and it must cover all the costs to continue if it not getting even normal profits which are already included in the cost, then it will shut down. It can continue if it is getting super normal profits:
But if it is getting losses as shown below, it will shut down.
Question 12. What is the supply curve of a firm in the short run?
Ans. The short run supply curve of perfect competitive firm is the summation of the upward sloping portion of SMC (above the minimum point of SAVC), when price ≥ min SAVC, and vertical portion of price-axis, when price < min SAVC.
When the price is greater than or equal to minimum of SAVC, i.e., P ≥ min SAVC.
At the market price OP, the three following conditions for equilibrium are fulfilled:
- MC = MR
- MC is upward sloping
- Price exceeds the minimum of SAVC
At this market price the firm is producing profit maximising output Oq1. In this case, the supply curve of the firm is regarded as the upward sloping part of SMC (above the minimum point of SAVC), i.e. SS. When the price is greater than or equal to minimum of SAVC, the supply curve is indicated by SS.
When the price is less than the minimum of SAVC
Let us suppose that the firm is facing price OP1 that is lesser than the minimum of SAVC. At this price, the firm cannot continue production as it cannot even cover up its variable costs and thereby incurs losses, which implies that the firm would produce nothing. Thus, it will incur loss that will be equivalent to its fixed costs. It will be lesser compared to the losses associated with producing any positive output level. Thus, the firm will not produce anything at this price and thereby the quantity supplied will be zero. The firm’s supply curve is indicated by the darkened vertical line S1S1.
Question 13. What is the supply curve of a firm in the long run?
Ans. The long-run supply curve in a perfectly competitive market has three parts; a downward sloping curve, a flat portion, and an upwards sloping curve. The long-run supply curves of a market is the sum of a series of that market’s short-run supply curves.Most supply curves are composed of three periods of production: a period of increasing returns to scale, constant returns to scale, and decreasing returns to scale. A long-run supply curve connects the points of constant returns to scales of a markets’ short-run supply curves.
Increasing returns to Scale
The stage of production in which output increases by more than the proportional increase in inputs is called stage of increasing returns to scale. In this situation Long Run Supply Curve is upward sloping.
Decreasing ng returns to Scale
Changes in output resulting from a less than proportional change in all inputs (where all inputs increase by a constant factor) and if output increases by less than the proportional change then there are decreasing returns to scale. In this situation Long Run Supply Curve is downward sloping.
Constant returns to Scale
Changes in output resulting from a proportional change in all inputs (where all inputs increase by a constant factor) and if output increases by that same proportional change then there are constant returns to scale (CRS). In this situation Long Run Supply Curve is a straight line.Long Run Supply in a Constant Cost Industry.
Question 14. How does technological progresses affect the supply curve of a firm?
Ans. If there is a change in the technique of production leading to a fall in the cost of production, supply of commodity will increase.
For example: New photocopy technique, printing technique, computerized calculations, etc. Such advancement will lower the Marginal Cost (MC) at each level of output.Thus, with technological advancement supply curve shifts to the right.
Question 15. How does the imposition of a unit tax affect the supply curve of a firm?
Ans. The government’s policy also affects the supply of a commodity. If heavy excise taxes are imposed on a commodity, it will discourage producers and as a result,its supply will decrease. It is because excise duty is levied on the total production cost of a firm. An increase in excise duty will raise firm’s total variable cost, which will raise MC curve. Thus, supply curve will also shift t the left.Thus, an increase in excise tax will shift the supply curve to the left and vice-versa.
Question 16. How does an increase in the price of an input affect the supply curve of a firm?
Ans. If there is an increase in price of an input, then MC of production will rise. As a result, supply of the good will fall because producers would prefer to produce some other commodities that can be produced at a lower cost. Thus, an increase in input price or cost will shift the supply curve to the left and vice-versa.
Question 17. How does an increase in the number of firms in a market affect the market supply curve?
Ans. If there is an increase in number of firms, there will be increase in supply. It is shown below:
Question 18. What does the price elasticity of supply mean? How do we measure it?
Ans. Alfred Marshall developed the concept of elasticity of supply. Price elasticity of supply is defined as the responsiveness of quantity supplied of a commodity to changes in its own price. The value of elasticity of supply will give the degree or quantity of change in supply to a change in price.
METHODS FOR MEASURING PRICE ELASTICITY OF SUPPLY
According to this method, elasticity is measured as the ratio of percentage change in the quantity supplied to percentage change in the price.Price Elasticity of Supply (Es)
Percentage change in Quantity supplied = Change in Quantity Supplied (DQ)
Initial Quantity Supplied (Q)
Change in Quantity (DQ) = New Quantity (Q1) – Initial
Percentage change in Price = Change in Price (DP) × 100
Initial Price (P)
Change in Price (DP) = New Price (P1) – Initial Price (P)
The percentage method can also be converted into the proportionate method. Putting the values of 1, 2, 3 and 4 in the formula of percentage method, we get:
Q = Initial Quantity Supplied
DQ = Change in Quantity Supplied
P = Initial Price
DP = Change in Price
Price Elasticity of Supply is Positive:
The elasticity of supply will always have a positive sign as against the negative sign of elasticity of demand. It happens because of the direct relationship between price and quantity supplied.
Three situations are there under geometric method:
- Any straight-line supply curve passing through the origin has a value of elasticity equal to one.
- If a straight-line supply curve goes through the quantity axis or X-axis, it is inelastic.
- If a straight-line supply curve goes through the price axis or Y-axis, it is elastic.
Question 19. Compute the total revenue, marginal revenue, and average revenue schedules in the following table. The market price of each unit of the good is rs. 10.
Question 20. The following table shows the total revenue and total cost schedules of a competitive firm. Calculate the profit at each output level. Determine also the market price of the good.
Question 21. The following table shows the total cost schedule of a competitive firm. It is given that the price of the good is rs. 10. Calculate the profit at each output level. Find the profit-maximizing level of output.
Difference between TR and TC is maximum at 5 units and after 5th unit profit is falling. Therefore both the conditions of the producer’s equilibrium are being fulfilled by TR-TC approach.
Question 22. Consider a market with two firms. The following table shows the supply schedules of the two firms: the SS1 column gives the supply schedule of firm 1 and the SS2 column gives the supply schedule of firm 1 and the SS2 column gives the supply schedule of firm 2. Compute the market supply schedule.
Question 23. Consider a market with two firms. In the following table columns labelled as SS1 and SS2 give the supply schedules of firm 1 and firm 2 respectively. Compute the market supply schedule.
Question 24. There are three identical firms in the market. The following table shows the supply schedule of firm 1. Compute the market supply schedule
Question 25. A firm earns a revenue of
50 when the market price of a good is 10. The market price increases to
15 and the firm now earns a revenue of 150. What is the price elasticity of the firm’s supply curve?
Price elasticity of a firm’s supply curve is more than unitary because with increase in price total revenue is also increasing.
Question 26. The market price of good changes from 5 to 20. As a result, the quantity supplied by a firm increases by 15 units. The price elasticity of the firm’s supply curve is 0.5. Find the initial and final output levels of the firm.
Question 27. At the market price of rs.10, a firm supplies 4 units of output. The market price increases to rs.30. The price elasticity of the firm’s supply is 1.25. What quantity will the firm supply at the new price?
- NCERT Solutions for Class 12 (All Subjects)
- NCERT Solutions for Class 12 Economics
- The Theory of the Firm under Perfect Competition Class 12 Notes Economics Part A Chapter 4