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1. From the following determinants of the price elasticity of demand, indicate the correct code for the determinants having a positive relationship with the degree of the price elasticity of demand:
(a) Range of substitutes of the commodity
(b) The extent of the different uses of the commodity
(c) A portion of the income of the buyer spent on the commodity
(d) Income group of buyers purchasing the commodity

  • Option : C
  • Explanation : The following are the main factors which determine the price elasticity of demand for a commodity:
    (i) The Availability of Substitutes: If for a commodity close substitutes are available, its demand tends to be elastic. If the price of such a commodity goes up, the people will shift to its close substitutes and as a result, the demand for that commodity will greatly decline. The greater the possibility of substitution, the greater the price elasticity of demand for it. If for a commodity substitutes are not available, people will have to buy it even when its price rises, and therefore its demand would tend to be inelastic.
    (ii) The Proportion of Consumer’s Income Spent: The greater the proportion of income spent on a commodity, the greater will be generally its elasticity of demand, and vice versa. The demand for common salt, soap, matches, and such other goods tend to be highly inelastic because the households spend only a fraction of their income on each of them. When the price of such a commodity rises, it will not make much difference in consumers’ budget and therefore they will continue to buy almost the same quantity of that commodity and, therefore, the demand for them will be inelastic.
    (iii) The Number of Uses of a Commodity: The greater the number of uses to which a commodity can be put, the greater will be its price elasticity of demand. If the price of a commodity having several uses is very high, its demand will be small and it will be put to the most important uses and if the price of such a commodity falls it will be put to less important uses also and consequently, its quantity demanded will rise significantly. To illustrate, milk has several uses. If its price rises to a very high level, it will be used only for essential purposes such as feeding the children and sick persons. If the price of milk falls, it would be devoted to other uses such as preparation of curd, cream, ghee, and sweets. Therefore, the demand for milk tends to be elastic.
    (iv) Complementarity between Goods: Complementarity between goods or joint demand for goods also affects the price elasticity of demand. Households are generally less sensitive to the changes in the price of goods that are complementary with each other or which are jointly used as compared to those goods which have independent demand or used alone. For example, for the running of automobiles, besides petrol, lubricating oil is also used. Now, if the price of lubricating oil goes up, it will mean a very small increase in the total cost of running the automobile, since the use of oil is much less as compared to other things such as petrol. Thus, the demand for lubricating oil tends to be inelastic.
    (v) Time and Elasticity: The element of time also influences the elasticity of demand for a commodity. Demand tends to be more elastic if the time involved is long. This is because consumers can substitute goods in the long run. In the short run, the substitution of one commodity by another is not so easy. The longer the period of time, the greater is the ease with which both consumers and businessmen can substitute one commodity for another.
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2. Match the items given in List-I with those given in the List-II and suggest the correct code:

(a) Marginal Productivity/Average Productivity(i) Isoquant Curve
(b) Substitutability of inputs(ii) Isocost Line
(c) Constant Negative Slope(iii) Production Function
(d) Convex to Origin(iv) Elasticity of Production

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4. Despite differences in the cost of production, the oligopolists will not vary the prices of their products as per which combination of the following models?
(a) Collusion model
(b) Cournot’s model
(c) Kinked Demand model
(d) Price Leadership model
Select the correct code.

  • Option : C
  • Explanation : 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 types 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 against consumers.
    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.
    ”Some of the benefits of collusion are as follows:
    (i) Helps organizations to increase their performance
    (ii) Helps organizations in preventing uncertainties
    (iii) Provides opportunities to prevent the entry of new organizations
    Cournot’s Model of Oligopoly: Augustin Cournot, a French economist, was the first to develop a formal oligopoly model in 1838 in the form of a duopoly model. Cournot developed his model with the example of two firms, each owning a well of mineral water and water being produced at zero cost. To illustrate his model, Cournot made the following assumptions.
    (a) There are two firms, each owning artesian mineral water well;
    (b) Both the firms operate their wells at zero cost;
    (c) Both of them face a demand curve with a constant negative slope;
    (d) Each seller acts on the assumption that his competitor will not react to his decision to change his output and price. This is Cournot’s behavioral assumption.
    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 behaviour of oligopolistic organizations remain stable when the price and output are determined. A kinked demand curve represents the behaviour pattern of oligopolistic organizations in which rival organizations lower down the prices to secure their market share, but restrict an increase in the prices.
    Following is 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 not follow increase in prices.
    (iii) Assumes that there is always a prevailing price. The Price Leadership Theory: The key the behavioural assumption in the price leadership theory is that one firm in the industry—called the dominant firm—determines the price and that all other firms take this price as given. Suppose that there are ten firms in an industry, A–J, that firm A is the dominant firm, and that firm A is much larger than its rival firms. (The dominant firm need not be the largest firm in the industry; it could be the lowest-cost firm.) The dominant firm sets the price that maximizes its profits, and all other firms take this price as given. All other firms, then, are seen as price takers; thus, they equate price with their respective marginal costs.
    The price leadership explanation suggests that the dominant firm acts without regard to the other firms in the industry and simply forces the other firms to adapt.
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