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National Income, is a measure of the value of production activity of a country.
This definition raises further questions : –
The answers to these two questions leads us to the concept of Economic Territory or Domestic Territory and Resident.
Economic Territory:
Economic territory is the geographical territory administered by a government within which persons, goods and capital circulate freely.
Only those parts of the country are included here where the government of that particular country, enjoys absolute freedom in it’s operation. For these reasons the Embassy of India in Germany is included in Economic Territory of India and Embassy of Germany in India is included in Economic Territory of Germany.
Scope : –
The above definition covers : –
Normal Resident:
A resident, whether a person or an institution, is one whose centre of economic interest lies in the economic territory of the country in which he lives.
Let’s understand this with help of an example: Mark, an American citizen has been living in India for past 5 years and he works in Mumbai. His earnings will be calculated as part of India’s National Income.
Exceptions : –
There are certain exceptions to this rule as under : –
Now we come to other definitions which are important while calculating National Income.
Factor Income:
It is the income which arises for rendering factor services. Eg Wages, Salary, Rent etc. It arises because it is the payment against the services provided. It is always included while calculating National Income.
Transfer Income:
It is the income which just gets transferred and against which no productive services had been provided. Eg Lottery winnings, Sponsorship, Shyam living in USA sends money to his family living in New Delhi etc. These incomes are not included while calculating National Income.
Final Goods:
Final goods are those goods which are used for final consumption. It is included while calculating National Income.
Intermediate Goods:
Intermediate goods are those goods and services which are used as raw material for producing further goods and services. It should be used in the same year.
Whether a good is a Final good or Intermediate good it depends on the ‘Nature of the use of the product’. Eg when baker buys sugar it is a intermediate good as she will use it for the purpose of baking. But when an household buys sugar, it is a final good as it for final consumption.
A stock is the quanity which is measured at a particular point of time e.g Bank balance as on 31st March is Rs 45000, 2015, number of machinery in a factory at given date etc. It influences the flow, Greater a stock of money balance in an account, greater will be the flow during a particular month. It is a static concept and doesn’t have an element of time attached to it.
Flow is the concept which is measured over an interval of period of time. Eg bank balance for a particular month or a particular year, number of births during a particular year. National Income is also a flow concept as it measures income of a country over given period time. They have an element of time attached to it.
Meaning
Stock – A stock is the quanity which is measured at a particular point of time
Flow – Flow is the concept which is measured over an interval of period of time
Time Element
Stock – They do not have an element of time attached to it.
Flow – They have an element of time attached to it eg 1 month, 3 months, 1 year etc
Concept
Stock – It is a static concept.
Flow – It is a dynamic concept.
Example
Stock – Capital, Bank deposits etc
Flow – Consumption, National income, Investment etc
Let’s have a look at different type of goods i.e, Final Goods and Intermediate Goods that we come across in Economics:
Final Goods are used those goods which are used for final consumption or for capital formation.
Intermediate Goods are those goods which are used as raw material in production of other goods in the same year.
Whether a good is a final good or intermediate goods it depends upon the use of the product.
For Example: A bakery buys sugar. He uses sugar in the production of cakes, cookies then it is a intermediate good for a bakery.
When a household buys a sugar, then it is considered as Final good as it is for consumption and not for sale.
Ultimately, the value of intermediate good is added into final good. Continuing with the above example, The baker buys sugar for Rs 100. And then he sells cake for Rs 500. In this example the value of intermediate good that is sugar is added in final good.
One important thing to keep in mind, if an intermediate good is not used within a year, then it is calculated as a part of final goods.
Only Final Goods are calculated as part of National Income.
Capital Goods:
Capital Goods are those goods which are used to make consumer goods and services.It is utilised by business to make goods for customers. In longer run, high demand of capital goods serves as a boast to economy.These include plant and machinery, hardware, other buildings, hardware, machines etc
Consumer Goods:
Consumer Goods are those goods which help to satisfy our needs and wants directly. They are ready for sale and bought for final consumption. Example pastries, services of a barber, mobile phones etc.
They consist of durable goods and non-durable goods. Goods which are for one time use like services of barber, eating pasteries are non durable goods. Goods which can be used over a period of time are durable goods like fridge, laptop, mobile phone etc.
The purpose of a good is wht makes it a capital good or consumer good.
Example: When firm buys telephones like a call center, then it is a capital good but if an individual buys a telephone then it is consumer good as it is for self satisfaction.
“Monopoly” is a market structure which is formed and differentiated from other markets on the basis of number of sellers, substitute of products, procedure for entry and exit etc. It is the strict opposite of perfect competition. Let’s learn more about Monopoly.
The word ‘Monopoly’ is derived from Greek words ‘mono’ which means single, and ‘polus’ which means seller. Monopoly refers to a market situation where there is a single seller , selling a product which has no close substitutes. For example, Indian railways is a Monopoly India.
Under Monopoly, there is only one seller , who is selling a certain product. Therefore, the monopoly firm (single seller) and industry (since there is only one seller, he would constitute the industry) are the same entities. The monopolist, has complete control over the supply and price of the product. However, there are large number of buyers of monopoly product, and no single buyer can influence the market.
Th product produced by a monopolist has no close substitute.So the firm has no fear of competition from the existing or new products.
There are strong barriers to entry of new firms , and exit of existing firm. As a result, a firm under monopoly can earn abnormal profits and losses in the long run. Such barriers might be due to legal limitations like licensing (it is difficult to obtain license) or patent rights (the product made by monopolist is patented which restricts others from producing it) or due to restrictions created by other firms in form of cartel.
A monopolist may charge different prices for their product , from different sets of consumers at the same time. It is known as ‘Price Discrimination’. Price discrimination refers to the practice of the seller charging different prices from different buyers at the same time for the same product.
Firm and industry are one and the same thing in such a type of market. So, the firm has complete control over the industry output. As a result, monopolist is a price maker and fixes his own price. He can influence the price in the market by changing the supply of the product.
A firm enjoys monopoly when it is the only seller of a certain product, and the product has no close substitutes. The fundamental cause of this is the barrier to entry. The reasons for emergence of such a market are –
A monopoly firm is like an industry as there is only one single seller that constitutes the entire market for the product, which has no close substitutes. So, a monopolist has full freedom and power to fix the price for the product. However, the demand of the product is not in the control of the firm. In order to increase the output to be sold, the firm will have to lower the price. As a result, the firm faces a downward sloping demand curve.
(graph 1)
In the figure given above, output is measured along the X-axis and revenue and price is measured along the Y-axis. At OP price level, a seller can sell OQ quantity of product. As the price is reduced to OP1, demand rises to OQ1. So, the demand curve under a monopoly is negatively sloped because more quantity can be sold only at a lower price.
A firm in monopoly faces a downward sloping demand curve as more output can be sold only by reducing the price. As a result, revenue generated from every additional unit, i.e. MR, is less than price, i.e. AR, of the product. Due to this reason, MR is less AR (MR<AR).
Equilibrium refers to a state of rest when no change is required. Like a consumer, a producer also aims to maximize his satisfaction to attain equilibrium. But a producer’s satisfaction is maximized in terms of profits. Let us see how a producer reaches equilibrium.
Profit – Profit refers to the excess of receipts from the sale of goods over the expenditure incurred on producing them. The amount received from the sale of goods is known as revenue, and the expenditure incurred on production of such goods is known as cost. The difference between revenue and cost is known as profit. For example, if a firm sells goods for Rs. 10 crores after incurring an expenditure of Rs. 7 crores, then profit will be Rs. 3 crores.
A firm or producer is said to be in equilibrium when there is no inclination to expand or contact the production or output. In this state, the producer has either maximum profits or minimum losses. Producer’s equilibrium refers to that combination of price and output which brings maximum profit to the producer and profit declines as more is produced. Producer’s equilibrium can be determined through the Marginal Revenue and Marginal Cost Approach (MR-MC Approach).
According to MR-MC approach, producer’s equilibrium refers to the stage of that output level at which –
As long as MC is less than MR, the producer can make more profits i.e. it is profitable for the producer to go on producing more because profits will increase. He stops producing more only when MC becomes equal to MR.
We know that MR is the addition to TR from sale of one additional unit of output and MC is the addition to TC for increasing production by one unit. The aim of every producer is to maximize profits. To achieve this aim, the firm will compare its MR and MC. Profits will increase as long as MR exceeds MC and the profits will fall if MC is greater than MR. So, producer equilibrium is not achieved when MC<MR as there is scope to increase profits. The producer will also not be in equilibrium when MC>MR because the benefit is less than the cost. It means the firm will be at equilibrium when MC=MR.
When MC is greater than MR after equilibrium it means producing more will lead to decline in profits. MC=MR is a necessary condition but it is not sufficient to ensure producer equilibrium. This is because MC=MR may occur in more than one level of output. However, out of these, only that level of output is the equilibrium output when MC becomes greater than MR after the equilibrium. It is because if MC is greater than MR, then producing beyond MC-MR will reduce profits. But, if MC is less than MR, then producing beyond MC=MR will be profitable. Therefore, the first condition must be supplemented with the second condition to attain producer’s equilibrium.
In the figure given above, output is shown on the x-axis and revenue and costs on the y-axis. Both AR and MR curves are straight line parallel to the x-axis. MC curve is u-shaped. Producer’s equilibrium will be determined at OQ level of output corresponding to point K because only at point K, both the conditions are met.
Although MR-MC is satisfied at point R, it is not the point of equilibrium since the second condition, that MC be greater than MR after MC=MR, is not satisfied.
Monopoly and monopolistic competition are imperfect competition market situations. In Imperfect Competition the price does not remain constant. In monopoly and monopolistic competition, price falls with rise in output. Let us see how the revenue curves behave in these situations.
Monopoly refers to a market situation where there is a single seller selling a product which has no close substitutes. In monopoly, there is a single seller and the product that he sells has no close substitutes. There is also restriction on the entry and exits into the industry. This enables the monopolist to set his own price or charge different prices from different sets of consumers at the same time. Therefore, in a monopoly, the firm is a price maker.
Monopolistic Competition refers to a market situation in which there are large number of firms which sell closely related but differentiated products. Markets like soap, toothpaste, AC etc. are examples of monopolistic competition. Buyers of a product differentiate between the same product from different firms. Therefore, they are also willing to pay different prices. Thus, the firm or the seller has partial influence on price.
Under imperfect competition, a firm follows its own pricing policy. Monopoly and monopolistic competition fall under the category of imperfect competition. However, the firm can increase its sales only by decreasing the price. When firms can increase their sales only by decreasing the price of the product, the AR falls with increase in sale. It means that revenue from each additional unit, i.e. MR, will be less than AR. As a result, both AR and MR curves slope downwards.
As we can see in the above schedule and graph, both AR and MR fall with increase in the number of outputs sold. However, the fall in MR is double than that in AR. In other words, MR falls at a rate twice the rate of fall in AR. As a result, the MR curve is steeper than the AR curve because MR is concerned with one unit, whereas AR is derived from all the units of output sold. This leads to a comparatively lesser fall in AR than the fall in MR.It must also be noted that MR can fall to zero and further fall to become negative, whereas AR can never be zero or negative since TR is always positive.
As we already know, both Monopoly and Monopolistic Competition fall under the category of Imperfect Competition. Therefore, under both market situation, AR and MR curves slope downwards as more and more units of output can be sold only by reducing the price. However, there is one major difference between the AR and MR curves of Monopoly and Monopolistic Competition.
Under monopolistic competition, the AR and MR curves are more elastic, i.e. more sensitive and prone to change, as compared to the AR and MR curves under monopoly. This happens because of the presence of close substitutes under monopolistic competition which are absent under monopoly. When the price of a commodity is increased in both markets, then the proportionate fall in demand under monopoly is less than the proportionate fall in demand under monopolistic competition.
In other words, if the price of a commodity is increased, under monopolistic competition, the consumers can turn to close substitutes of that commodity for lower prices, therefore the fall in demand is higher. Whereas under monopoly, the consumers do not have any substitutes and have to buy the commodity at the price decided by the producer, therefore the fall in demand is not as much as that in monopolistic competition.
As seen in the diagrams, the AR and MR curves under monopolistic competition are more elastic as compared to the AR and MR curves under monopoly.
The revenue curve of a firm is majorly represented by the Average Revenue and Marginal Revenue curves of a firm. These curves show the behaviour of the revenue of a firm. Let us see how the revenue curve of a firm behaves under perfect competition
Perfect competition refers to a market situation where there are a very large number of buyers and sellers who deal in identical product. Under perfect competition, the price of the commodity is fixed by the market. There are a huge number of sellers selling identical products, therefore a single producer cannot influence the price by changing the level of output. Thus the firms are called price takers. They have no market control and receive the market price for their output.
In perfect competition. a firm has to accept the same price as determined by the industry. The firm can sell any quantity of a commodity at that particular price. Therefore, it can be said that the price remains constant. When the price remains same at every level of output, it means that no firm is in the position to influence the price. This means that, the revenue from every additional unit (MR) is equal to AR. We also know that AR is equal to price since,
TR = Quantity × Price
AR = TR/Quantity = Quantity × Price/ Quantity
Therefore, AR = Price
As a result both AR and MR curves coincide in a horizontal straight line parallel to the x-axis.
As seen in the given schedule and diagram, price or AR remains constant at all levels of output and are equal to MR. As a result, AR curve is perfectly elastic. This means a firm can sell any quantity of output at the constant price.
When price remains constant, firms can sell any quantity of output at the given price. As a result, the MR or AR curve is a horizontal straight line parallel to the x-axis. Since MR remains constant, TR also increases at a constant rate. Due to this, the TR curve is a positively sloped straight line. As TR is zero at zero level of output, the TR curve starts from the origin.
Revenue is the amount of money that a producer receives for his commodity. It is very important for us to understand the concept of commodity and how it works.
The amount of money that a producer gets in exchange for the sale proceeds is known as revenue. Revenue refers to the amount received by a firm from the sale of a given commodity in the market. For example, a firm gets Rs. 16,000 from the sale of 100 chairs, then the amount of Rs. 16,000 is known as revenue.
The concept consists of three terms – Total Revenue, Average Revenue and Marginal Revenue.
Total Revenue (TR) refers to the total receipts from the sale of a given quantity of commodity. It is the total income of a firm. TR is obtained by multiplying the quantity of the commodity sold with the price of the commodity.
TR = Quantity (Q) × Price (P)
For example, if a firm sells if a firm sells 10 chairs at the price of Rs. 160 per chair, then the TR will be,
TR = 10×160 = Rs. 1600
Average Revenue (AR) refers to revenue per unit output sold. It is obtained by dividing the total revenue by the number of units sold.
AR = TR ÷ Q
For example, if TR from the sale of 10 chairs at Rs. 160 per chair is Rs. 1600, then,
AR = TR÷Q = 1600÷10
AR = Rs. 160
AR curve and price are the same. We know that AR equals to per nit receipts and price is always per unit. Since sellers receive revenue according to price, price and AR are one and the same.
TR = Q×P
AR = TR ÷ Q
AR = Q×P/Q
Therefore, AR = P
Marginal Revenue (MR) refers to the additional revenue generated from the sale if a additional unit of output. It is the change in TR from one more unit of commodity.
MRn = TRn – TRn-1
Where,
MRn = MR of nth unit
TRn = TR from n units
TRn-1 = TR from (n-1) units
n = number of units sold
We now know that MR is the change in TR when one more unit of output is sold. However, when change in units sold is greater than one unit, then MP can be calculated as,
MR = Change in TR/ Change in number of units
MR = ΔTR/ΔQ
The supply schedule shows the combinations of different quantities of a commodity that a producer is willing to sell at different levels of price. The graphical representation of a supply schedule is known as a Supply Curve.
A Supply Curve is the locus of all the points showing various quantities of a commodity that a producer is willing to offer for sale at various levels of prices, during a given period of time, assuming no change in other factors.
This shows that there is direct relationship between price and the amount of a commodity that will be supplied by a producer or a firm, keeping other factors constant. It can be drawn for any commodity by plotting each combination of a supply schedule on a graph. It can be drawn for both the types of supply schedules – individual and market supply schedule. Therefore, it is of two types – Individual and Market.
An individual supply curve is a graphical representation of an individual supply schedule.
SS is obtained by plotting points shown in the schedule given above. At every possible price, the firm is willing to sell a specific amount of its commodity. By joining all these points we obtain a curve that slopes upwards. This is due to the positive relationship between the price of a commodity and the quantity supplied.
Market supply curve is a graphical representation of a market supply schedule. We obtain it through horizontal summation of individual supply curves.
The points in market supply schedule given in the above table are graphically represented in the given graph. Sm has been obtained by horizontal summation of SA and SB.
A market supply curve is flatter than all the individual supply curves, because with change in price, the proportionate change in market supply is more than the proportionate change in individual supply.
The slope of a curve is defined as a change in the variable on the Y-axis divided by the change in the variable on the X-axis. Therefore, the slope of a supply curve is the Change in Price divided by the Change in Quantity Supplied.
Slope of Supply Curve = Change in Price (ΔP)/Change in Quantity (ΔQ)
Due to the direct relationship between supply and price, the curve slopes upwards i.e. the slope is positive. The slope measures the flatness or steepness of the curve. So it is based on the absolute change in price and quantity.
When the price rises from Rs. 4 to Rs. *, Then the quantity rises from 2 units to 4 units. Therefore,
Slope = Change in Price (ΔP)/Change in Quantity (ΔQ)
Change in Price (ΔP)/Change in Quantity (ΔQ) = 8-4/4-2 = 2
As a Supplier of Commodity, one would like to supply a particular quantity when the price are high. However, if there is a fall in the price, the supplier would like to sell a different quantity. In other words, there is a change in the quantity supplied of a commodity (increase or decrease), due to a change in its price (increase or decrease in price). The extent of change in the quantity supplied of a commodity , due a given change in the price of the commodity , is determined by the Price elasticity of supply of that commodity.
The concept of price elasticity of supply points out the reaction of the Sellers , to a particular change in the price of the commodity. It explains the quantitative changes in the supply of a commodity, due to a given change in the price of the commodity.
Price elasticity of supply refers to the degree of responsiveness of the supply of a commodity , with reference to change in the price of the commodity.
Price elasticity of supply can be measured through the following methods : –
The most common method for measuring the price elasticity of supply (we would refer to it as “ES“) is the Percentage Method, which is also known as the proportionate method. According to the Percentage method, Price elasticity of Supply is measured as the ratio of (a) Percentage change in the quantity supplied to (b) the percentage change in price.
Price Elasticity of Supply Formula – Percentage Method
ES = %ΔQ/%ΔP
Where,
ES – Price Elasticity of Supply
ΔQ – Change in quantity supplied = ( New Quantity after change (Q1) – Initial Quantity before change (Q) )
%ΔQ – Percentage Change in Quantity Supplied = (ΔQ/Q ) ×100
ΔP – Change in Price = New Price after change (P1) – Initial Price before change (P)
%ΔP – Percentage Change in Price = ΔP/P ×100
Example –
Suppose, at the price of Rs. 10 per unit, a firm supplies 50 units of a commodity. When the price rises to Rs. 12 per unit, the firm increases the supply to 70 units. The price elasticity will be calculated as,
ES = %ΔQ/%ΔP
%ΔQ = Change in quantity supplied/Initial Quantity ×100
%ΔQ = ΔQ/Q ×100
%ΔQ = (70-50)/50 ×100 = 40%
Similarly,
%ΔP = ΔP/P ×100
%ΔP = 12-10/10 ×100 = 20%
ES = 40%/20% = 2
ES = 2
The percentage method can be converted into proportionate method
ES = (ΔQ/Q ×100)/(ΔP/P ×100)
ES = ΔQ/P × ΔP/Q
So far we have seen that the concept of elasticity of supply is similar to that of elasticity of demand. However, unlike elasticity of demand, elasticity of supply will always have a positive sign. This occurrence is due to the direct relationship between price and quantity supplied.
According to the Geometric method, elasticity is measured at a given point on the supply curve. This method is also known as the arc method or the point method. The measurement of elasticity of supply for the supply curve SS can be measured as explained below.
At point A, the price is OP and the quantity supplied is OQ. When the price rises to , quantity supplied also rises to . The supply curve is extended beyond the Y-axis, so that it meets the X-axis at point L. At point A, elasticity of supply is equal to,
Price Elasticity of Supply Formula – Geometric Method
ES = ΔQ/ΔP × P/Q
From the diagram,
ΔQ = QQ1
ΔP = PP1
P= OP
Q = OQ
Therefore,
ES = QQ1/PP1 × OP/OQ
But,
QQ1 = AC, PP1 = BC, and OP = AQ
ES = AC/BC× AQ/OQ ………1
Now, ΔBAC and ΔALQ are similar triangle on account of AAA property of similar triangles, therefore the ratio of their sides will be equal.
AC/BC = LQ/AQ……………2
Substituting this value in equation 1, we get,
ES = LQ/AQ× AQ/OQ
ES = LQ/OQ = Intercept on X-axis/Quantity supplied at that price
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