Economics Notes Chapters 11 to Chapter 17

The best and high-quality Economics Notes Class 11 | FA Part-1 chapter-wise, Chapters 11 to Chapter 17 for all Pakistani Educational boards.

Economics Notes Chapter 11 (Scale of Production and Laws of Returns)

Q.1) Define Scale of production, Marginal and Average product, Total product, Economies of scale. 

The scale of Production: 
The scale of production denotes the aspects used the quantities of commodities produced and the techniques of production adopted by a producer.
Marginal and Average Product: 
Marginal product is the amount of goods/services produced with the addition of one additional unit of input (such as one labor hour or one lb of apples). Average product is the amount of goods/services produced by a firm divided by the total amount of inputs.
Total Product: 
The total product is the overall quantity of output that a firm produces, usually specified in relation to a variable input.
Economies of Scale: 
Economies of scale are the cost advantages that enterprises obtain due to their scale of operation, with cost per unit of output decreases with increasing scale.

Q.2) Discuss the advantages and disadvantages of large-scale production.  

Advantages of Large-Scale Production:
1. Economies of Buying and Selling Large scale producers can buy raw materials and other inputs at cheaper rates and favourable terms. Because large-scale producers can afford a lower margin of profit, he is able to boost sales resulting in higher profit. A large producer will buy in a cheaper market and will sell in the dearer market. A firm like BATA, but not a small shoemaker, can buy leather from any cheaper market; domestic or international
2. Use of High-Tech Machines Bigger enterprises can afford and have greater scope for use of expensive modern and computerized machines (even robots) which help them lower unit costs and improve the quality of the product.
3. Division of Labour Large scale producers’ organizations their production based on division of labour. They follow the principle “right man for the right job. Specialized labour produces larger and high-quality output at a lower cost. A SUZUKI car reaches buyers after going through the hands of hundreds of workers or even robots.
4. Experiments and Research Big businesses can afford expensive research and experiments. Ultimately, they reap it benefits in the form of lower costs, new products and more efficient processes of production. Toyota and Philips companies employ hundreds of scientists / researchers to improve their products. Frequently, they bring new models and better-quality products.
5. Advertisement and Publicity Large scale producers, attract their buyers through extensive advertisement and salesmanship. As their output is quite large, the cost of advertisement per unit of output is not high. Advertisement at the scale done by WALLS and SONY can not be afforded by small producers.
6. Use of By-products Big businesses can easily manage to use their by-products or waste materials. Such use helps them in reducing the average cost of production of the main product e.g. sugar mills use the stock of molasses for preparing power alcohol.
7. Face Adverse Times Large companies can face adverse and unfavourable situations effectively. A small-scale producer simply collapses and is forced to close the business during such hard times. PIA runs into loss many a time but continues the business, since it can cover the loss in future years.
8. Credit Facility Another merit of big businesses is that they can easily avail of the opportunities of cheap credit and other privileges from financial institutions while the small businesses cannot. SHELL Petroleum or Pakistan Steel can get easy credit from banks.
9. The economy in Fixed Cost Due to the larger output of big enterprises, them per-unit cost 1. account of administration rent and interest on loans is reduced.

Disadvantages of Large-Scale Production:
1. Individual Choice Ignored Large enterprises produces standardized products. This Tack of variety reduces the consumer’s choice. You can select shoes at Bata but cannot get it changed according to your taste. From a small shoemaker, you can do so
2. Difficulty in personal supervision It is difficult for big manufacturers to be aware of all the details of the business. They remain busy in tackling major problems. Dishonesty prevails among employees and they cause damage and waste of materials
3. Possibility of Over-Production Due to a miscalculation of future market, big businesses may produce more than what can be sold at current prices. Thus, overproduction occurs, and unemployment takes place.
4. Lack of Personal Contact with employee’s Large-scale producers cannot remain in touch with the individual grievances of employees. Misunderstanding develops between both parties, which leads to strikes and lockouts. The workers do not remain loyal to their employer’s interests.
5. Lack of Adaptability It is difficult for big concerns to make necessary adjustments according to changing conditions. In periods of depression, only small producers can easily shift to some new business.
6. Close Competition Big companies frequently indulge in the wasteful competition which ultimately proves harmful to them. Diamond Foam and Molty Foam may lose profit in the fight to oust each other.
7. Dependence on Foreign Markets Large scale enterprises usually must depend on foreign markets. If due to war or strained relations, their markets are cut-off, the businesses suffer huge losses.
8. No sense of achievement. In large scale production, the principle of division of labour is applied. Each worker has a small contribution in the final product. Workers cannot have the satisfaction to claim that I have made this product.

Q.3) What is meant by the scale of production? What factors determine the Scale of Production? 

The scale of production plays a vital role in determining the cost of production. The scale of production includes the size of a business, the number of inputs used and the volume of production. If a firm has a large capacity and especially when it produces goods with the help of modern machines, we call it large-scale production. For example, the manufacturing of cloth in a big textile mill is large-scale production. On the other hand, if the cloth is produced in limited quantity on a hand loom, it is known as small-scale production. When the market for a good is large to sell it, producers prefer to produce on a large scale. An increase in the scale of business reduces the average cost of production and increases profits. The advantages, which a firm gets by expanding its size and capacity, are called economies of scale.
Factors determine the Scale of Production:
1. Financial Resources The larger the scale, the larger would be the expenditure on machines, building, raw materials, advertisement, etc. If the organizer can collect a large amount of capital (from his own pocket or bank credit) he would prefer large scale business, otherwise, he continues a small scale. Single owners usually have limited amounts of capital, so they adopt a small scale. Joint-stock companies by selling shares can collect huge resources and can adopt a large scale. e.g. BATA produces millions of shoes, Toyota manufactures millions of cars.
2. The extent of Market Goods is produced to be sold. if the product has limited market demand, the scale of production will be smaller. But if the commodity is in wider use, and can be easily sent to distant places, the large scale will be adopted.
3. The elasticity of demand also influences the decision. If the demand is elastic i.e. by lowering price, sales can be increased, a large scale will be preferred. Increased production will reduce the unit cost of output and bring in higher profits.
4. Transport Facilities Development of transport facilities expands the market and supports large scale production.
5. Technical Possibilities about production, storage, transport or marketing determine the scale of production. Some goods technically cannot be produced on small scale e.g. cement, steel, so large scale is essential. Some goods like shoes can be produced on any scale. A few years ago, when trucks with freezers were not available, ice cream was produced and sold on a small scale, e.g. on shops
6. Organizational Ability The ability of the organizer has a key role in the selection of scale. If the organizer is ambitious, can take the risk; has the experience to supervise large businesses, has the courage to compete with rival corporations, he will prefer a large scale. Since it is difficult to combine all these qualities in one individual, he can hire people with specialized training. Individual owners mostly work on a small scale while joint-stock companies opt for a large scale.

Q.4) Write the Advantages and Disadvantages of Small-Scale Production. 

Advantages of Small-Scale Production:
1. Adaptability Small scale manufacturers can easily switch over to a changed atmosphere. They do not face any difficulty and delay in taking quick and prompt decisions because they need not consult shareholders for such changes.
2. Contact with Consumers Small businesses develop regular contacts with the consumers and, thus, do not ignore their interests and choices. Such an attitude involves a lesser amount of risk.
3. Sympathetic towards Workers Small business concerns are found sympathetic and considerate to their employees. They give a patient hearing to their problems and grievances. The possibility of strikes and lockout is minimized.
4. Proper Supervision Small producers are mostly individual owners or partnerships. They can easily look after the business. Chances of fraud and wastage are reduced.
5. Variety of Product Small businesses do not stick to standardized products, rather they offer changing varieties and designs as demanded by the buyers. Go to some shopping centre and you will be surprised to see the variety of ladies and gents’ shoes.

Disadvantages of Small-Scale Production: 
1. Old methods of production Due to scarcity of capital, small producers rely on old-fashioned methods of production. The quality of the product remains poor and costs high.
2. Difficulty in Division of Labour Due to a small operation, the scope for the division of labour is reduced. Their per-unit cost remains high. In a small health centre, there is no scope for employing specialist doctors.
3. Scarcity of Funds Small firms generally faces the problem of scarcity of funds. Banks prefer to deal with bigger firms.
4. Wastage Small scale producer is unable to make proper use of by-products. They may go waste resulting in the high cost of the main product.
5. Diseconomy in Buying and Selling A small producer buys raw inputs in small quantities. He has to pay a higher rate.
6. Less ability to face bad times Business conditions do not remain constant. and or prices of products may fall. In such cases, it is very difficult for a small to pull on and continue in the business.


Q.8) Derive average and marginal product curves from a total product curve. 

Derive average and marginal product curves from a total product curve
Economics Notes Chapters 11 to Chapter 17 21

Q.9) Discuss Internal and External Economies of Scale in detail. 

Internal Economies
The advantages which a firm gets from the expansion of its business are called internal economies.
Internal economies are classified under five heads.
A. Technical Economies
Arise because of possibility for the division of labor and the use of machinery increases.
i) Specialization and division of labor. Large businesses break down the production process into smaller jobs and hire specialists for each job. This increases the efficiency of labor. Example: in a Riksha one person is both a driver as well as driver i.e. One person manages two passengers. But on a bus, the two jobs (driving and conducting) are performed by different persons so two workers can manage 50 passengers. Thus, the cost per passenger is reduced.
ii) Specialized machinery is used by large firms which reduces unit cost. In big car assembly plants, a lot of tasks are performed by computerized machines and robots. Example: to construct a small house, cement, and sand may be mixed by hands. But in the case of large buildings, huge concrete mixers are used. Pepsi Cola uses a bottle washer while a person selling a few homemade bottles of ‘sharbat’ (cold drink) cannot do so.
iii) Initial cost and the operating costs of one large machine will be lower than two or more small machines doing the same work. For example, the cost of running a bus will be less than if the same passengers are transported by two wagons.
iv) Less wastage of materials and energy and by-products e.g. for transporting and storing oils, use of bigger tanks and tankers will reduce. In sugar mills, along with sugar large quantity of molasses is produced which can be used to produce alcohol,
v) Research and development departments of large enterprises innovate and introduce new products which increase their total profits.
B. Managerial
In large-scale production, management costs per unit of output fall. Suppose, the “My output of a firm is 1000 shirts and it has a manager with a salary of Rs. 100,000. The management cost per shirt is 100,000 / 1000 = 100 rupees. Later
100,000 / 1000 = 100 rupees. Later the firm expands increases output to 2000 shirts. Now the management cost is 100,000 / 2000 = 50 rupees per shirt. “
C. Commercial (or Marketing economies)
A large firm buys from the cheaper markets and sells in the dearer market. When a firm buys raw materials in bulk, it gets a concessional rate. For example, if Bata purchases shoe polish from Kiwi, it will be charged a lower rate than normal.
Publicity and advertisement are easier for large firms. They spend huge amounts and use expensive media for publicity, yet their average cost does not rise because on larger scales.
D. Financial Large:
Companies can get easy credit from banks on favorable terms. So, it is easier and cheaper for NESTLE to get a bank loan of 500 million rupees than for a small soap factory to get a loan of 50 thousand rupees.
E. Risk Bearing
Large firms “do not put all eggs in one basket”. Often, they produce a whole variety of goods. So, their chances to meet bad times are brighter. Small businesses usually produce a particular good or service. If for some reason, demand for their product falls, they are in trouble. Companies like Samsung and Phillips do not confine themselves to a single product.

External Economies:
External economies mean the favourable effects which reduces the average cost of the product as the industry grows. The fall in cost is experienced by the whole industry and not just an individual firm.
External economies are of three kinds.
1. Economies of Concentration:
As the industry expands and companies concentrate in an area, it becomes easier for them to get specialized skilled labor, needed raw materials, and services of specialized institutions. There is

  1. Establishment of Subsidiary industries
  2. Establishment of related workshops
  3. Expansion of network of transport and communication facilities
  4. Increase in banking services
  5. A whole network of suppliers and specialists comes up.

Sialkot has a concentration in the sports industry. It requires little effort to get trained workers and raw material to make football while it is difficult to do so in Quetta.
2. Economies of Information:
Expansion of industry encourages the spread of information and research. Special journals and publications appear to highlight the problems of a industry. The companies come to know new methods and processes.
In Pakistan, because of the large textile industry, many publications are available which discuss its working or issues.
3. Economies of Disintegration:
When industry grows, complementary and specialized enterprises are established. The electric fan industry is concentrated in Gujranwala and Gujrat. Here more and more companies are specializing in the production of only some part of fans.

Q.10) Write a note on the Production Function.

The relationship between the number of factor inputs and the quantity on resulting output is called production function.

A production function shows how the quantity of output changes as the number of factor inputs is changed. In the production function, both output and inputs are measured in physical units (like tons, meters, etc.) and not in rupees. Production of a commodity requires the combined use of many factors. The relationship between the number of factor inputs and the quantity of resulting output is called a production function. We can also define it as Production function is the technological relationship, which shows the maxi num amount of physical output obtainable from various combinations of factor inputs.
The purpose of a production function is to tell us just how much output we can produce with varying amounts of factor inputs. The following table shows a simple production function about the sewing of shirts using two inputs labor and capital.
In functional notation, we can write a general production function as,
Q = f (A, B, C, D) Where Q is the quantity of output, while A, B, C, and D are different productive factors such as land, labor, etc. If we assume that technology, as well as organization and land, do not change, while labor L and capital K are variable, then the production function can be written as
Q = f (L, K)

Read more: Economics Notes Class 11 Cha 5 to Cha 10


Class 11 Notes Economics Chapter 12 (Market and Revenue Analysis)

Q.1) Define Market, Perfect market, Short period market, Perfect competition, Monopoly, AR. MR. 

Market: A market is a place where two parties can gather to facilitate the exchange of goods and services. The parties involved are usually buyers and sellers.
Perfect Market: A market in which buyers and sellers have complete information about a product and it is easy to compare prices of products because they are the same as each other.
Short Period Market: when the supply of the goods is fixed, and so it cannot be changed instantaneously. Say for example the market for flowers, vegetables. Fruits etc. The price of goods will depend on demand.
Perfect Competition: The Perfect Competition is a market structure where a large number of buyers and sellers are present, and all are engaged in buying and selling.
Monopoly: A market structure characterized by a single seller, selling a unique product in the market.
AR: The total receipts from sales divided by the number of units sold.
MR: Marginal revenue is the additional revenue that will be generated by increasing product sales by one unit.

Q.2) What is the Market? Describe its various kinds. 

A market is a mechanism, or arrangement, which brings together buyers (demanders) and sellers (suppliers) of goods or services.
A group of buyers and sellers that exchange goods or services at a price.

The market can be classified on different bases

  1. According to a period of time.
  2. According to location
  3. According to the nature of commodity
  4. According to the nature of competition.

Markets according to Time:
i) Daily Market
It is a very short period market e.g. for a day or so. The price of a commodity in such a market is settled based on supply available immediately in the market. A new supply of goods cannot come out of farms or factories. Because supply is fixed, the price will increase or decrease according to changes in demand only.
The daily market of perishable commodities has a special feature. These commodities cannot be stored for a longer period. Whatever supply has arrived in the market has to be sold without delay. This fact causes wide fluctuations in the prices of commodities.
Example: Suppose on a day, 100 trucks of tomatoes have arrived in City Vegetable Market. Now, this whole quantity must be sold in a day or two. If there is enough demand for tomatoes, the price will go high. But if the number of customers is less, the price may fall to a very low level. Thus, in the daily market, the deciding factor about price is demand.
ii) Short Period Market:
In such a market, adjustments in supply can be made within the existing productive capacity of the industry. If due to higher demand, price starts rising, firms produce and supply more output. Suppose a firm has a monthly production capacity of 1 million bottles of jam. It is not necessary that the firm always produces full capacity. The actual supply will range between zero to 1 million, depending upon the condition of demand. During a short period, new businesses cannot be established.
iii) Long Period Market: 
In this type there is a large scope for expansion and contraction of supply. Due to a long period of time, necessary changes can take place in the industry to meet permanent shifts of demand for the commodity. In the long period market, the fluctuations in prices are small and smooth. If a factory producing jam wants to increase its production capacity by installing new machines, it will require a lot of time.

Markets According to Location
i) Local Market
It is a limited market comprising of a small area when goods are produced and sold which are difficult to transport to far-flung example, bricks and ice, fresh bread and fresh milk.
ii) Regional Market:
This is a market where those goods are sold and purchased. Which are produced and consumed in a region. Because of high transportation costs or lack of demand in other regions the market is limited. For example, the market for milk, Sindhi-shawl, and earthenware.
iii) National Market: 
This market extends to the whole of a country. The national market exists for those goods which are demanded in all parts of the country and can be transported easily from one region to another. Example: wheat, bulbs, and cloth.
iv) International Market:
This market spreads over more than one country. It may extend to the whole world. The goods, which are demanded internationally and can be produced on a large scale, are exchanged in this market. Example: cars, computers, gold, oil, machinery. On-line sales / purchases are now common. The Internet has promoted the extension in markets.

Markets According to the Nature of Commodity
i) General Market:
Where all kinds of goods are sold. For example, Liberty Market or Anarkali in Lahore, Aabpara in Islamabad and Qisa Khwani in Peshawar.
ii) Specialized Markets to Particular Commodity:
It is bought and sold i.e. cloth market, fruit market, auto market, electronics market, gold market or Urdu Bazar (books market), Bakker-mandi. The specialized market may also be
a) market factor e.g. labor market where employers and job seekers make a bargain.
b) capital market e.g. stock exchange market where shares of companies are traded.
c) money market where borrowers and lenders make agreements about loans.
d) foreign exchange market where dollars and other foreign currencies are bought and sold
e) resource markets e.g. labor market, capital market.
iii) Marketing through Samples Some goods such as grains and medicines etc. are usually sold through samples e.g. agents of firms visit medical stores / doctors to sell medicines
iv) Marketing through Grades:
Many goods are sold on the basis of grades and trademarks e.g. watches and electric goods are sold by trademarks e.g. SONY TV, Phillips bulbs, Suzuki cars, BATA shoes, Lipton Tea, Nokia phone.

Markets According to the Nature of Competition
i) Perfect Market (Competitive Markets)
A market where (i) the number of buyers and sellers is large (ii) the product is homogenous and (iii) a single buyer or seller is unable to influence the market price is called perfect market. In such a market every buyer and seller is well informed about the facts of the market. In a perfect market, the price of a commodity will be the same throughout the market. Perfect markets do not exist in practice.
ii) Imperfect Market:
Any market where conditions of perfect competition are missing. It may be in the form of Monopolistic Competition: Where many companies exist selling close substitutes. The basic product is the same e.g. computers produced by different companies. But the companies, by making some changes in design, quality, packing, etc., make their product somewhat different from other firms’ products. Through publicity, low price or other tactics they attract customers
Duopoly Two sellers who may compete as in monopolistic competition or may cooperate (collude) and make a cartel to get high profits e.g. Kiwi Shoe Polish and Cherry Blossom in Pakistan.
Oligopoly few sellers who may compete or compromise to sell e.g. toothpaste makers
Monopoly single seller who controls the market supply and market price. e.g. WAPDA in electricity supply.
Monopsony (single buyer). e.g. in Pakistan atomic scientists can be employed by the government only, so the government has monopsony in this case.

It means the marketing of products or services over the internet or through e-mail. It is also called online marketing. Internet marketing is inexpensive i.e. has an extremely low cost to reach customers. It costs companies a small fraction of traditional advertising budgets. e-marketing is growing fast.

Q.3) Distinguish between Perfect and Imperfect Market. 

A market will be called perfect if the following necessary conditions exist there.
i) A very large number of buyers and sellers An individual buyer and seller is not in a position to influence the market price. He must follow the market price. He may sell more quantity or less but the price in the market will not be affected
ii) Homogeneous of the product (standardized product) It means that all units of a commodity sold by the firms are identical and the buyers have no preference for the product of any firm. It means that no seller can charge a price different from the market.
iii) Freedom of entry and exit This situation ensures that the firms get only normal profit and supply remains elastic. If profits go high for a certain product, new companies have no restriction to enter this line of production.
iv) Perfect mobility of factors This condition means that factors like labour and capital will tend to move to better uses and places. It ensures quick adjustments in supply in response to changes in demand.
v) Perfect Information All the parties in the market have full knowledge of market conditions and prices. Such knowledge forces the sellers to sell their products at the prevailing market price and the buyer to buy at that price.
vi) Unrestricted movement of the commodity in all parts of the market Perfect market requires that the commodity is freely available at one price everywhere in the market. Even if some small difference exists in price at various places equal to the cost of transport of goods from production point to selling the place, the market will still be called perfect.

When all or some of the conditions of the perfect market are not present, the market is called the imperfect market. In such a market, individual companies or sellers can influence the price of the commodity.
A. SUPPLY side Imperfect Market
i) Monopolistic Competition (Many companies producing close substitutes):
In monopolistic competition, the basic product is the same e.g. fans produced by different companies. But the companies, by some changes in design, quality, packing, etc., can make their product somewhat different from other firms’ products. Then, through publicity or lower price or other tactics, try to attract customers.
ii) Oligopoly (few sellers):
The few firms know each other and react to the pricing and marketing decisions of rival companies. They may compete as in monopolistic competition or may cooperate (collude) and make a cartel to fix a high price e.g. firms selling motorcycles in Pakistan.
iii) Duopoly (two sellers):
The position of the duopoly is just like an oligopoly. The firms decide their price and output in the light policies of the other firm. They may compete and start price war or may cooperate (collude) and make a cartel to keep prices high e.g. Kiwi Shoe Polish and Cherry Blossom.
iv) Monopoly-single Seller:
Who fully controls the market supply and market price of a product. e.g. WAPDA in electricity supply. B. DEMAND side imperfect market Monopoly (single buyer). e.g. in Pakistan atomic scientists can be employed by the government only, so the government has monopsony in this case.


Q.5) What is a Monopoly? What are its kinds? Describe the evils of Monopoly. 

“Monopoly is made of two words — ’Mono’ and “Poly. ‘Mono’ means single and ‘Poly’ means the seller. Thus, ‘Monopoly refers to a market situation where one firm or a group of firms which are combined to have a control over the supply of the product.
Kinds of Monopoly
1. Simple Monopoly and Discriminating Monopoly:
A simple monopoly firm charges a uniform price for its output sold to all the buyers. While a discriminating monopoly firm charges different prices for the same product to different buyers. A simple monopoly operates in a single market a discriminating monopoly operates in more than one market.
2. Pure Monopoly and Imperfect Monopoly:
Pure monopoly is the type of monopoly in which a single firm controls the supply of a commodity that has no substitutes, not even a remote one. It possesses an absolute Monopoly power. Such a Monopoly is very rare. While imperfect monopoly means a limited degree of Monopoly. It refers to a single firm that produces a commodity having no close substitutes. The degree of Monopoly is less than perfect in this case and it relates to the availability of the closeness of a substitute. In practice, there are many cases of such imperfect monopoly.
3. Natural Monopoly:
When a Monopoly is established due to natural causes then it is called natural monopoly. To-day India has got Monopoly in mica production and Canada has got a Monopoly in nickel production. These Monopoly natures have provided to these countries.
4. Public Monopolies:
In the general interest of the nation, when a government nationalizes certain industries in the public sector, whereby industrial or public monopolies are created. The Industrial Policy Resolution 1956, in India, for instance, categorically lays down that certain fields like arms and ammunition, atomic energy, railways, and air transport will be the sole monopoly of the Central Government. In this way, industrial monopolies are created through statutory measures.

A monopoly cannot be considered an evil. There are many instances where it is beneficial, rather essential in the interest of the society e.g. public utilities such as gas, water supply, and electricity. These are natural monopolies in the sense that the firms providing these services must spend huge sums and produce very large output to bring down their average cost. If many companies can produce at a small scale in some areas, it will be just wastage of resources. Similarly, patent rights and registered designs are helpful in encouraging innovations. Monopolist firms also spend huge amounts on research and development of products. They produce a large scale so they can do so more efficiently than small competitive firms. overall, monopoly has many evil effects especially when the monopolist firm is privately owned. The following are the important points of criticism against it.
1. Restrictive Effects:
The monopolist finds it possible and profitable to restrict output as compared to competitive producers. I have deprived the people of larger output.
2. Higher Price:
The monopolist charges a higher price than a competitive firm. He can maintain above-normal profits even in the long run. The consumers are exploited. If a monopoly situation ends due to the entry of news firms, the price will tend to fall.
3. Anti-Social Policies:
The monopolist wants higher profit. He may produce a commodity that is demanded by a small section of the society and ignore the larger interest of the common people e.g. production of costly watches.
4. Misallocation of Resources:
Welfare of the society requires that the level of output should be fixed at that point where MC = Price. But price under monopoly is above marginal cost and does not maximize the welfare of the society. “The monopolist does not use resources at their best potential efficiency.
5. Supernormal Profit and an increase in inequality of incomes:
The monopolist makes supernormal profits. This increases inequality in the distribution of incomes of the people.
6. Unemployment:
The monopolist restricts output to raise the price and earn higher profits. I have fewer people. So, unemployment takes place.
7. Slow Technical Progress: 
The monopolist has a secure market and no rivals. His incentive to develop new products and new techniques is weak. This retards technological progress.

Q.6) What is the Perfect Competition? Describe its Salient Features.

Perfect competition is a market situation where single buyers or sellers are unable to influence price of a commodity. An individual or firm may sell or buy any quantity the market price is not affected.
Salient features of Perfect Competition:

  1. Consumers get commodities at cheaper rate
  2. Producers use the most efficient methods to reduce cost.
  3. Factors of production like land, labor and capital get good rewards.

Q.7) Name two commodities for which perfect competition exists. Also, name two Monopolies. 

In a perfect market, the price of a commodity will be the same throughout the market. In Pakistan, the wheat market can be considered as a nearly perfect market.
Riksha service in Lahore or taxi service in Islamabad is also an example of a perfect market.
Single Producer (or Single Firm) The whole market supply consists of the production of a single firm. It is, thus, a single-firm industry. The price of the product is entirely controlled by the monopolist e.g.

  1. WAPDA is a monopolist in the electricity market since it controls its total supply. 
  2. Railway is a monopolist in the mean of transport.

KPK 1st year FA Economics Notes Chapter 13 (Cost of Production and Cost Curves)

Q.1) Define the Cost of production. 
Explicit cost. Implicit cost. Normal profit, Pure profit, short period, Long-period, Fixed cost. Variable cost. Opportunity cost, Marginal cost.

Cost of Production: 
Cost of production is the sum of all such expenses, which a producer has to bear for producing a commodity.
Explicit Cost: 
Explicit cost is the firm’s actual cash payment to others for purchase of inputs.
Implicit Cost: 
Implicit cost is the opportunity cost of non-purchased inputs owned by a firm itself.
Normal Profit: 
Normal profit is a form of implicit cost. It is the minimum profit which is require to keep a firm in business.
Pure Profit: 
The pure profit differs from the accounting profit in the sense, it takes into account the implicit or imputed cost while calculating the profit of a firm. The implicit cost is called an opportunity cost.
Short Period: 
A short period is that in which slight variation can be made regarding the demand for the goods. The demand for the goods can be increased to some extent and if the demand diminishes, it can be reduced.
Long-period provides enough time to adjust the demand of the customers for the products. The price is mainly determined based on demand and supply.
Fixed Cost: 
The cost which do not change with output in the short run are called fixed cost
Variable Cost: 
It is the cost which is directly varies with the change in the level of output.
Opportunity Cost: 
The opportunity cost, or alternative cost, of making a choice is the value of the most valuable choice out of those that were not taken.
Marginal Cost: 
Marginal cost is the change in the total cost that arises when the quantity produced is incremented by one unit; that is, it is the cost of producing one more unit of a good.

.3) Differentiate between ‘short-run’ and ‘long run’ costs. How is the long-run average cost curve derived from short-run cost curves? 

There are two Main Differences:
1. There is no fixed cost in the long run. All factors of production become variable. The size and capacity of the firm can be changed according to demand. So, there is no need to draw a fixed cost curve.
2. In the long run, all factors are completely divisible. Various factors can be combined in any proportion. Therefore, optimum utilization is possible. It is because of this fact that they are flatter than short period cost curves i.e. they fall slowly, reach their minimum point, and then start rising slowly.
Derivation of Long Run Average Cost Curve
The long-run average cost curve can be derived from short-run average cost curves in the following way. Suppose, a firm can produce a certain commodity with five different sizes of plants.


Derivation of Long Run Average Cost Curve
Economics Notes Chapters 11 to Chapter 17 22

To start with, the firm has a smaller plant. The short-run average cost curve of this plant is shown as SAC1. If the firm feels that the demand for its product has risen
permanently and the capacity of plant No. 1 is not enough to meet new demand, it installs a bigger plant. For this, it must face short-run average cost curve SAC2. Similarly, for still bigger plants the firm’s short-run average cost curves will progressively assume the position SAC3, SACand SAC5. So long as the demand for the commodity is Qo or less, it will use plant No. 1. But if demand has permanently increased beyond OQo, it will have to shift to the next bigger plant to reduce the average cost. For example, if the demand for a commodity is OQ1, the average cost on the first plant is AQ1, while if for the same output, the second plant is used, the average cost falls to BQ1, Thus, it is clear that it is in the interest of the firm to use plant No. 2, provided the time is long enough to allow the installation of this plant. Similarly, we see that if the demand for output increases beyond OQ1 the firm will have to use the next bigger plant to keep the average cost at a minimum. Proceeding in this way we find that the long-run average cost of the firm will consist of the curves M1M2, M2M3, M3M4, and M4M5 i.e. bold parts of the various short-run average cost curves.

To start with the firm has a smaller plant output
Economics Notes Chapters 11 to Chapter 17 23

In the above diagram, we have taken only five plants but if we assume that the size of the plants can be varied continuously and indefinitely, the long-run average cost curve will become just a tangent to the short-run average cost curves as shown in fig. below.

The long-run average cost curve is also called the Envelope Curve due to its peculiar shape. The lowest point on LAC represents the optimum size of the firm and optimum output. If there is perfect competition in the market the firm will tend to produce at this size.

Q.4) What is the cost of production? Differentiate between Fixed and Variable Costs. 

Cost of Production:
Cost of production is the sum of all such expenses, which a producer has to bear for producing a commodity.
Cost are measured in money term and include such items as wages, rent, interest, and payment for raw materials, fuel, power, transport, taxes and so on.
Fixed Cost:
The costs which do not change with output in the short run are called fixed cost. Even if a firm produces nothing (i.e. output is zero) it has to bear the fixed cost.
Total fixed Cost includes the following:
i) The rent of the building and land
ii) Salaries of permanent staff
iii) Interest payments on debts
iv) Fixed taxes, if any e.g. annual license fee
Variable Cost
It is the cost, which directly varies with the changes in the level of output. It arises because of variable inputs. If a firm produces nothing (has zero output), the variable cost will be zero.
Variable Cost includes the following:
i) Cost of raw material
ii) Wages of labor
iii) Transport
iv) Electricity, fuel and power charges
v) Taxes such as excise duty and sales duty
vi) Sale commission
vii) Depreciation


Economics Chapter 15 (Equilibrium of Firm-Perfect Competition & Monopoly)

Q.1) Define the terms.

Perfect Competition, Equilibrium. Short-run. Long run. Normal profit., Shut down point, Price taker firm, Monopoly profit, Natural monopoly. Abnormal profit, Barriers to entry of firms.

Perfect Competition:
Perfect competition refers to a market form in which there are very large number of firms producing a homogeneous commodity.
Equilibrium Short-run: A short run competitive equilibrium is a situation in which, given the firms in the market, the price is such that that total amount firms wish to supply is equal to the total amount the consumers wish to demand
Equilibrium Long run:
The long-run equilibrium of a perfectly competitive market occurs when marginal revenue equals marginal costs, which is also equal to the average total costs.
Normal Profit: 
Normal profit is a situation where a firm makes sufficient revenue to cover its total costs and remain competitive in an industry.
Shut down Point: 
A shutdown point is a level of operations at which a company experiences no benefit for continuing operations and therefore decides to shut down temporarily (or in some cases permanently).
Price taker Firm: 
In a perfectly competitive market, the firm is a price-taker, it cannot influence the market price through the quantity it produces. In practice, this means the firm is so small in proportion to the overall market that it has no market power, so it can sell any quantity it is able to produce at the market price.
Monopoly Profit: 
The high economic profit obtained by a monopoly firm is referred to as monopoly profit. The existence of a monopoly, and therefore the existence of a monopoly price and monopoly profit.
Natural Monopoly:
A natural monopoly is a type of monopoly that exists due to the high start-up costs or powerful economies of scale of conducting business in a specific industry.
Abnormal Profit: 
Abnormal profit is a profit of a firm over and above what provides its owners with a normal market equilibrium return to capital.
Barriers to entry of Firms: 
Common barriers to entry include special tax benefits to existing companies, patents, strong brand identity or customer loyalty, and high customer switching costs.

Q.2) How can you find the maximum profit of a firm under perfect competition? Explain with curves. 

Maximum profit (AR > AC)
Abnormal or super normal profit arises when the per-unit cost of output (AC) is less than the market price (i.e. AR). In fig. at equilibrium output, average revenue is EQ while the average cost is TQ. Since EQ > TQ, the firm earns an abnormal profit on each unit equal to ET. The firm’s output is OQ (which equals EP). Total profit is found as:
Total profit = Per unit profit x Output
= ET x ST …………. (OQ = ST)
= PETS area (shaded)

Maximum profit
Economics Notes Chapters 11 to Chapter 17 24

Q.3) Explain the equilibrium of a firm in the short and long run under perfect competition. Make diagrams.

Short Run Short run refers to that period during which a firm’s size and productive capacity remain fixed and the number of firms in the industry is constant. The firms adjust their output to market demand by changing the variable factors only (e.g. labor)
There is some fixed factor in a short period, which cannot be changed (e.g. building). So there is a fixed cost, which the firm has to bear, even if it produces nothing. Thus, the total cost consists of two parts i.e. fixed and variable costs. The shape of cost curves will be as shown opposite.


Explain the equilibrium of a firm in the short and long run under perfect competition
Economics Notes Chapters 11 to Chapter 17 25

Long Run Long run is a time period of enough duration during which all factors of production become variable. The size and productive capacity of the firm can be increased or decreased according to market demand. There is no need to draw a fixed cost curve. In the long run, it is easy to adjust productive capacity at the ant level by adding machines or buildings, so AC and MC curves become flatter.

In the long run, companies, under perfect competition, can earn only normal profits. If due to some reason, prices go high and enterprises earn abnormal profits, the existing firms expand their size while new ones are attracted to enter the industry. The result will be that the supply of the commodity in the market will increase, prices fall, and abnormal profits disappear. On the other hand, if the price is so low that firms run into losses, some weak firms will have to leave the industry. Consequently, the supply of the commodity will decrease, and the price will rise until the remaining companies again earn normal profits.

The long-run equilibrium of a firm is explained in fig. Just as in the short run, the equilibrium position of the firm, in the long run, is determined at a level of output where long-run marginal cost (LMC) intersects marginal revenue (MR) curve from below.

Economics Notes Chapters 11 to Chapter 17 26

LMC and LAC are long-run marginal cost and average cost curves respectively. MR = AR = P is the marginal and average revenue line. Equilibrium is at point E where LMC = MR. OQ is the equilibrium output. At this output average cost also equals average revenue. So, the firm is earning only a normal profit. Long run equilibrium condition thus becomes LMC = MR = P = LAC.

Q.4) How price and output are determined under perfect competition in the short run.

In a short period, there are four possibilities in which a firm is working.
(a) It earns a super normal profit. (b) It earns a normal profit only. (c) It runs into losses.
(d) It faces a shutdown point.
The actual position of the firm depends upon the market price at which it must sell. If the price is higher than its per-unit cost of production, it will get profit. If the price does not cover its unit cost it has a loss.
a) Abnormal profit (AR > AC)
Abnormal or super normal profit arises when the per-unit cost of output (AC) is less than the market price (i.e. AR). In fig. (a) at equilibrium output, average revenue is EQ while the average cost is TQ. Since EQ > TQ, the firm earns an abnormal profit on each unit equal to ET. The firm’s output is OQ (which equals EP). Total profit is found as:
b) Normal Profit (AR = AC)
When a firm just covers its cost, it is said to get a normal profit since we define the cost of production to include normal profit at equilibrium output, average revenue and average cost are equal, (EQ = EQ). Since the AC curve includes normal profit, we say that the firm earns a normal profit.
c) Loss (AR < AC)
At equilibrium output average revenue (EQ) is less than average cost (TQ), the firm has to bear loss equal to TE on each unit of output. As the output is OQ (= PE), the total loss is equal to the shaded area STEP. In this position, although, there is a loss, it is better for the firm
d) Shut Down Point (AR = AVC)
In fig. (d) the price is so low that the firm is covering only its variable cost (EQ). Loss has laugh equal to total fixed cost. Thus, the firm is on a shutdown point. Whether it operates or not, the amount of loss remains the same. This loss is shown by the shaded area STEP. However, if price falls further, the firm must close down since the firm will be unable to cover not only fixed cost but also part of variable cost.

Q.5) Compare the equilibrium of a firm under conditions of perfect competition and Monopoly. 

1. Price-taker and Price-maker Under perfect competition, the industry consists of a very large number of firms and price is determined by their collective action. A single firm has no control over market price and is only a price-taker. In a monopoly, a single firm represents the whole industry and has the power to fix the price i.e. a monopolist is a price-maker.
2. The demand curve or AR curve of a firm under perfect competition is a horizontal straight line (perfectly elastic) and AR and MR curves are the same. In monopoly AR and MR, curves are different, downward sloping with MR curve lying below the AR curve.

Compare the equilibrium of a firm under conditions of perfect competition and Monopoly
Economics Notes Chapters 11 to Chapter 17 27

3. In perfect competition the equilibrium condition is 
MC = MR = P

Economics Notes Chapters 11 to Chapter 17 28

In Monopoly the equilibrium condition is MC = MR < P

4. In perfect competition, a firm is in long-run equilibrium at the minimum point of the long-run average cost curve. But a monopolist firm is in equilibrium at a point where AC is still falling and has not reached the minimum. In fig. The equilibrium of the monopolist firm is at output level OQ at which average cost is AQ. It is not the minimum AC which is MQ.

Economics Notes Chapters 11 to Chapter 17 29

5. Under perfect competition, since the MR curve is horizontal, the second condition of equilibrium that MC cuts MR from below is met only when MC is rising. But under monopoly this second condition may be satisfied even when the MC curve is horizontal, falling or rising at the equilibrium output as shown below. Fig

6. While under perfect competition, in the long run, a firm can earn only normal profit, a monopolist firm may be earning super normal profit even in the long run. 

7. Under conditions of monopoly, the price set is higher and output smaller than under perfect competition, even if cost and revenue conditions are the same.

Economics Notes Chapters 11 to Chapter 17 30

Initially, there is competition in the market and DD is the demand curve. So is the supply curve. The equilibrium is at point E, the market price is OP, and output is OP NOW suppose all firms combine and make a monopoly.” The market demand curve now becomes the AR curve of the firm and MR is the marginal revenue curve of the firm. The new equilibrium is at point E’ where MC = MR. The output is OQ2 and the price is OP2. We find that after forming of monopoly, the price has gone higher and output smaller than what was under competition.

8. Price discrimination the monopolist can charge different prices for the same commodity from his customers. But a competitive firm is unable to do so. This policy of monopolist is called price discrimination.

9. In the case of perfect competition, there is the sovereignty of the consumer (i.e. only those goods will be produced which consumers want most). In a monopoly, there is a possibility of a producer’s sovereignty.

Decision choices 

10. In perfect competition, the firm is a price-taker, so it has only one choice i.e. a decision about the quantity produced. The monopolist is a price-maker. He has two options i.e. a decision about price or about the quantity produced. However, the monopolist cannot fix both simultaneously. If he fixes price, he cannot decide about quantity; which will be determined by demand. If he fixes the output produced; price will be determined by the demand of buyers.

Q.6) What is a Monopoly? How the price is determined under a Monopoly? 

A monopoly is a market situation in which there is a single firm producing a commodity that has no close substitute. Under a monopoly situation, the difference between firm and industry disappears. Because the total quantity of commodities consists of the production of one firm only, if the monopolist increases his output, the market supply increases and price falls. In the opposite case, if he reduces production, the market supply decreases and price rises. In this way, the monopolist can control the price by his own policy. We can say the monopolist is a price-maker. (A firm in perfect competition is price taker-it cannot change market price)
Revenue Curves
Because increased production results in lowering of price, average revenue (AR) and marginal revenue (MR) curves are downward falling as shown in fig.
For a monopoly firm, MR is always less than the price at all levels of output.

Economics Notes Chapters 11 to Chapter 17 31

Q.7) How a firm achieves equilibrium under Monopoly? Diagrams?  

Equilibrium or Profit Maximizing
Aim of a firm is to earn a profit. So it always tries to produce that much quantity of output at which total profit is maximum. This position of the firm is called equilibrium. To achieve equilibrium under a monopoly, the firm has to compare the marginal cost of production and the marginal revenue. If the cost of producing an additional unit of output (MC) is less than the additional expected income (MR), the firm will increase production. It will adjust production at a level where the following two conditions must be fulfilled.
i) Marginal Revenue = Marginal Cost (MR = MC)
ii) MC curve cuts the MR curve from below. (i.e. Slope of MC > Slope of MR)

Equilibrium in Short Run So far as the period is concerned, in the short-run, a monopolist can face any of the four possibilities encountered by a competitive firm i.e. abnormal profit, normal profit, losses and shut down position. However, since the monopolist has control over price, he earns an abnormal profit in most cases. Losses are rare. This situation of abnormal profit is shown in fig  (a) and loss in fig (b).

Equilibrium or Profit
Economics Notes Chapters 11 to Chapter 17 32

AC and MC are the short-run averages and marginal cost curves. AR and MR are average and marginal revenue curves. Equilibrium is at point E where the MC curve cuts the MR curve from below. OQ is the profit-maximizing output. At this output TQ is the average revenue and HQ is the average cost. In fig (a) the firm earns TH abnormal profit on each unit of output. “Total profit is PTHS which is attained as follows:

Total profit = output x per-unit profit. = OQ X TH

= SH x TH ………. ………………. (Since SH = OQ)

= Area PTHS (Shaded) 

Equilibrium in Long Run:
In the long run, a monopolist always earns abnormal profits. This is unlike perfect competition where only normal profits exist. In long period, average and marginal cost curves are flatter than in the short run. However, the equilibrium again occurs where LMC cuts MR from below. The long run equilibrium is shown in fig

Economics Notes Chapters 11 to Chapter 17 33

Q.9) Discuss the evils of Monopoly.  

A monopoly cannot be considered an evil. There are many instances where it is beneficial, rather essential in the interest of the society e.g. public utilities such as gas, water supply, and electricity. These are natural monopolies in the sense that the firms providing these services must spend huge sums and produce very large output to bring down their average cost. If many companies can produce at a small scale in some areas, it will be just wastage of resources. Similarly, patent rights and registered designs are helpful in encouraging innovations. Monopolist firms also spend huge amounts on research and development of products. They produce a large scale so they can do so more efficiently than small competitive firms. overall, monopoly has many evil effects especially when the monopolist firm is privately owned. The following are the important points of criticism against it.
1. Restrictive Effects:
The monopolist finds it possible and profitable to restrict output as compared to competitive producers. I have deprived the people of larger output.
2. Higher Price:
The monopolist charges a higher price than a competitive firm. He can maintain above-normal profits even in the long run. The consumers are exploited. If a monopoly situation ends due to the entry of news firms, the price will tend to fall.
3. Anti-Social Policies:
The monopolist wants higher profit. He may produce a commodity that is demanded by a small section of the society and ignore the larger interest of the common people e.g. production of costly watches.
4. Misallocation of Resources: 
Welfare of the society requires that the level of output should be fixed at that point where MC = Price. But price under monopoly is above marginal cost and does not maximize the welfare of the society. “The monopolist does not use resources at their best potential efficiency.
5. Super normal Profit and an increase in inequality of incomes:
The monopolist makes super normal profits. This increases inequality in the distribution of incomes of the people.
6. Unemployment:
The monopolist restricts output to raise the price and earn higher profits. I have fewer people. So, unemployment takes place.
7. Slow Technical Progress:
The monopolist has a secure market and no rivals. His incentive to develop new products and new techniques is weak. This retards technological progress.

Q.10) Give three examples from the Pakistan economy in which you find a Total or Partial Monopoly. 

Following are the three example of Pakistan having monopoly in economy:

  1. WAPDA
  2. PTCL
  3. SSGC

Q.11) Given the figure below for a perfectly competitive firm, Determine firm’s equilibrium output, price, AC, AVC, AFC and per unit profit. 

Economics Notes Chapters 11 to Chapter 17 34


In the above diagrams output is shown along the x-axis while cost and revenue are measured along y-axis. AC, AVC and MR represent average total cost, average variable cost and marginal cost respectively. MR, AR and p represent the marginal revenue, average revenue and price. Marginal cost (MC) curve intersects MR curve at point E which equilibrium of the firm. OQ is the equilibrium output. At this output level MC = MR.

Economics Chapter 16 (Pricing of Factors of Production, Wages)

Exercise (Pricing of Factors)

Q.1) Define the terms. Factors of production, Marginal physical product, Marginal revenue product, Derived demand, Opportunity cost.

Factors of Production: 
The factors of production are resources that are the building blocks of the economy; they are what people use to produce goods and services. Economists divide the factors of production into four categories: land, labor, capital, and entrepreneurship.
Marginal Physical Product:
Marginal product, also called the marginal physical product, is the change in total output as one additional unit of input is added to production.
Marginal Revenue Product:
The marginal revenue productivity theory of wages is a theory in neoclassical economics stating that wages are paid at a level equal to the marginal revenue product of labor.
Derived Demand:
In economics, derived demand is demand for a production or intermediate good factor that occurs as a result of the demand for another intermediate or final good.
Opportunity Cost:
The opportunity cost, or alternative cost, of making a particular choice is the value of the most valuable choice out of those that were not taken.

Q.3) Which economic theory is hidden in the following formula:


Economics Notes Chapters 11 to Chapter 17 35


Economics Notes Chapters 11 to Chapter 17 36

Q.4) How is national income distributed among factors of production? Explain the assumptions and limitations of this formula.

Firstly, factor prices are the major determinant of the incomes of the people in the form of wages, rent, interest, and profit. In order to understand the mechanism of the national income distribution, analysis of factor pricing is needed.
We must know why a worker is getting Rs. 20,000 a month and not more. Why the rents of houses are rising? Why the pay of an officer is higher than a clerk and why banks charge 10% as interest?
Secondly, just as product prices ration finished goods and services to consumers, factor prices allocate scarce resources among various uses. To make this allocation efficient, understanding of the process of factor pricing is helpful.
Thirdly, to the companies, factor prices are costs. To earn maximum profits the companies must seek the least-cost combination of resources. For this purpose, they take into consideration the relative prices of various factors hired.
Finally, the question of factor pricing is closely related to the ethical and political problems regarding inequality in the distribution of incomes and the effects of public policy. For example, the problem of a fall in product prices is less serious than a fall in wages.
Explain the assumptions and limitations of this formula.
When we consider many factors employed at a time the general rule becomes Proportionality Rule: All factors earn rewards (prices of factor services) in proportion to their contribution in the marginal product). The firm chooses that level of output where the following condition is satisfied. See the development of this formula in Explanatory Notes.

How is national income distributed among factors of production
Economics Notes Chapters 11 to Chapter 17 37

This assumption means that the firm under consideration is one of a very large number of buyers of this type of labor and cannot influence the wage rate, the supply of labor (to the firm) will be perfectly elastic at the ruling wage rate. It can get as many workers as it desires at the market wage.

Exercise (Wages)

Q.1)  Define the terms. Wages, Nominal wages, Real wages, Equilibrium wage, Trade union, bargaining power of labor, Collecting bargaining, Minimum wage. 

Wages : A fixed regular payment earned for work or services typically paid on a daily or weekly basis.
Nominal wages: Nominal wages are wages expressed in a monetary form, and which do not consider changes in prices.
Real wages: Real wages are wages adjusted for inflation, or, equivalently, wages in terms of the number of goods and services that can be bought.
Equilibrium wage: The equilibrium wage rate is determined where quantity of labor supplied is equal to the quantity to labor demand.
Trade union: An organized association of workers in a trade, group of trades, or profession, formed to protect and further their rights and interests.
Bargaining power of labor:
Bargaining power is the relative power of parties in a situation to exert influence over each other.
Collecting bargaining:
Collective bargaining is a process of negotiation between employers and a group of employees aimed at agreements to regulate working salaries, working conditions, benefits, and other aspects of workers.
Minimum wage:
Minimum wages have been defined as “the minimum amount of remuneration that an employer is required to pay wage earners for the work performed during a given period, which cannot be reduced by collective agreement or an individual contract.

Q.2) Explain the theories for the Determination of Wages. 

Wages are the price for the services of labor, so like any other price, wages are determined by demand and supply of labor.
To explain the equilibrium in the labor market and the determination of the wage rate, we make two assumptions.
i) Perfect competition
ii) Absence of trade unions, First of all, we analyze the forces behind demand and supply of labor.
Demand for Labor
Demand for labor in some industries is the total number of workers employed by all the companies in the industry at different wage rates.
Many factors affect this demand:
a) Demand for labor is indirect and is derived demand from the demand for goods it produces. Labor is demanded not for its own sake but because it helps to produce goods.
b) Demand for labor is affected by the availability of other inputs needed to put labor to work i.e. raw materials, capital equipment and the state of technology.
c) Demand for labor depends upon the prices of other factors. If the prices of raw materials rise, the firms may reduce the demand for labor. Similarly, if some machines, which can be substituted for labor become cheaper, the demand for labor falls.
d) Labor demand is also affected by the business, social and political environment.
e) Labor demand is related to the marginal revenue product of labor (MRP)

Explain the theories for the Determination of Wages
Economics Notes Chapters 11 to Chapter 17 38

Supply of Labor

The supply of labor is the number of workers offering themselves for employment at various possible wage rates.

The supply of labor depends upon the conditions in the labor market e.g.

i) Size of the total population. This sets the upper limit to the supply of labor.

ii) Age and sex composition of the population. A higher percentage of children and older people reduce labor supply

iii) State laws regarding working hours, employment of women, number of holidays.

iv) Current wage rate Higher wages induces people to increase working hours.

iv) An increase in the mobility of labor increases the supply of labor.

v) The cost of education and training required for the job reduces supply in a occupation.

vi) The attitude of workers towards work and leisure.

Q.3) Differentiate between Money wages and Real wages. What factors contribute to real wages?

Money Wages
By nominal wages, we mean the total amount of money earned by a person during a certain period – per hour, per day and so on. For example, if a person receives Rs.20,000 per month as his salary, this amount is his nominal wage. Nominal wages are generally those money payments that a person regularly receives in cash e.g. rupees per day, per week or per month.
But money wages or nominal wages alone do not give us a correct idea of what a worker really earns from his work. For this purpose, real wages are estimated. Real wages
Real Wages
Real wages are the total amount of goods, services, and facilities that a worker enjoys by working on a job.
The purchasing power of money wages in the form of goods and services is called real wages. If we want to find out the standard of living of a worker, it is estimated not from nominal wages but from his real wages.
Factors affecting real wages
1. Money Income Higher money wages mean a greater capacity to buy goods. A person getting Rs 2000 / – a day is in a better position to buy commodities than a person getting Rs 1000
2. Purchasing Power of Money The level of prices determines what a person can really buy with his money income. When prices rise, the purchasing power of money falls e.g. hundred rupees in 2000 could purchase than a thousand rupees can buy in 2018. If the money wages of a worker are not increasing at the rate of rising in prices his real wages will fall.
3. Opportunity for extra and supplementary income If a person has opportunities of earning extra income in a certain occupation, his real wages will be higher than the other without such opportunity. If a college lecturer gets extra income by marking examination papers, his real wages will be higher than his colleague who does not do such extra work. In those employments where bonuses are paid, real wages will be higher.
4. Other Facilities If two persons get equal money wages but one of them is getting a free residence, conveyance, meals or free medical facilities, then his real wages will be greater than the other. All expenses of an army soldier are borne by the government, so his wages are more than another employee with the same money wages.
5. Nature or conditions of Work In some occupations, where the work is quite easy and pleasant or working hours are short, real wages will be higher. For example, the job of a magistrate is more pleasant than a factory supervisor. Even if both get equal money wages, the real wages of the magistrate are higher. In risky jobs the wages paid will be less attractive than equal money wages in other jobs.
6. Free extra work If an employee is required to do extra work without any compensation, his real wages will be less. For example, if a peon must work after office hours without any extra payment, his real wages will be lower.
7. Prospects If a person has good prospects of promotion in the future his real wages will be higher than a person who has no chance of promotion. Bright chances in the future are a source of satisfaction. In pensionable posts, real wages will be higher although the current salary may be equal to the non-pension able job.
8. Permanent Job gives security and makes easy to plan one’s future. Thus a person with a permanent job will have higher real wages compared to the person with equal money wages but a temporary job.
9. Social Status Wages of a magistrate and a sales manager may be equal, but because of better social status real wages of the magistrate will be higher.
10. Expenses of Training and education have an inverse relation with wages. If two workers get the same money wages, but the period and cost of training of one are less than the other, then the real wages of the first will be higher.

Q.4) What are Trade Unions? What are their functions?  

Trade Unions
Trade unions are phenomena of the modern industrial world. During the industrial revolution in the nineteenth century, when the factory system was introduced, the power of the capitalists and employers increased manifold against the working class. The laborers were totally left at their mercy. The exploitation of labor, which had been going on through centuries in one form or the other, became severe. Underpayment, overwork, lack of facilities, unpleasant working conditions, insecurity of job, employment of innocent children became the lot of working classes. Gradually, as they worked at one place in large numbers, the workers started realizing the importance of their collective strength. The laboring class became aware of the miserable treatment given to them by the employers. They developed a sense of common interest and an urge for joint efforts to change their lot. They realized that they could improve their conditions of work only through co-operation and combined efforts. Thus, trade unions came into being.
Functions: The main functions of trade unions are the following.
i) To raise wages of the laborers.
ii) To increase the bargaining position of workers through collective and to get their grievances redressed.
iii) To improve conditions of service, including holidays, pensions, hours, determination of seniority, etc.
iv) To act as a link between the workers and management.
v) To improve the working conditions of their members. To ensure, hygienic and pleasant atmosphere in the factories and workplaces.
vi) To provide financial aid to unemployed and sick workers.
vii) To control the supply of labor – by introducing qualifying tests licenses for professions and longer periods for an apprenticeship.

Q.5) How wages are determined? What is the role of the MP in wage determination?

Wages are the price for the services of labor, so like any other price, wages are determined by demand and supply of labor.
To explain the equilibrium in the labor market and the determination of the wage rate, we make two assumptions.
i) Perfect competition
ii) Absence of trade unions, first, we analyze the forces behind demand and supply of labor.

KPK G11 Economics notes Chapter 17(Rent, Interest, Profit)

Exercise (Rent)

Q.1) Define the terms.
Rent, Economic rent, Gross rent, Net or pure rent, Quasi rent, Differential rent, Scarcity rent, transfer earnings.

A tenant’s regular payment to a landlord for the use of property or land.
Economic Rent:
Economic rent is any payment to an owner or factor of production in excess of the costs needed to bring that factor into production.
Gross Rent:
Gross rent is the amount of rent stipulated in a lease, as divided up across the months for which the renter is responsible for paying.
Net or Pure Rent:
Net rent or economic rent is the amount paid to the land owner use of land.
Quasi Rent:
Quasi rent is that temporary rent which arises due to fixed supply of any factor other than land.
Differential Rent:
Differential rent refers to the rent that arises owing to differences in fertility of the land.
Scarcity Rent:
Scarcity rent is the cost of “using up” a finite resource because the benefits of the extracted resource are unavailable to future generations.
Transfer Earnings:
Transfer earnings are the reward necessary in order to keep owners of factors of production supplying their resources.

Q.4) Define rent. Differentiate between Pure and Gross Rent.

Net or Pure Rent:
Net rent or economic rent is the amount paid to the landowner’s use of land. Any additional payment such as charges for use of tube well, building, machinery, etc. supplied by the landowner is not included in net rent. Thus, pure rent is the payment that is made only for the use of the surface of land or soil or against the extraction of minerals.
Gross Rent:
The total amount received by a landlord from the user of land is called gross rent. It includes the following elements.
i) Net rent which is purely the reward for services of land.
ii) The payment for use of the capital invested on land by the landowner in the form of the house, shed, tube well and drainage.
iii) Maintenance charges and depreciation for machinery and capital goods owned by the landlord being in use on that land.
iv) Wages of those workers who have been employed by the landlord to look-after land and collect rent from the tenant.

Q.5) State and explain the modern theory of rent. 

Modern theory of rent:
Modern theory of rent is a part of the general theory of prices which are determined by demand and supply. The theory applies not only to the determination of rent of land but also to rewards of all factors of production with a fixed supply.

quantity of land
Economics Notes Chapters 11 to Chapter 17 39

To keep the explanation of rent simple, we assume that; 

i) all land is of the same grade or quality. 

ii) land has just one use (say, it produces wheat only). 

iii) market is competitive i.e. many cultivators demand and many lands owner offer land rent.

Demand for Land 

Demand for land is derived or indirect demand. It depends on the demand for goods which land produces (or on the value of the marginal product of land). Because of the law of diminishing returns, the marginal product of land decreases. It means more land will be demanded only at the lowering of rent. Demand for land can arise at three levels 

(a) individual farmer. 

(b) industry (industry means a group of farmers producing the same crop). 

(c) The whole economy.

The demand curve of the industry (all farmers growing the same crop) is the sum of demand curves Rent of all individual growers of a crop. A typical demand curve for the land is shown in fig.

Supply of Land

The supply of land is also considered from three angles. From the standpoint of;

(a) firm

(b) industry

(c) economy as a whole.

For an individual farmer, the supply of land is perfectly elastic. By paying the current rent, he can cultivate as much additional land as he wants. Thus, the supply curve for him is a horizontal straight line parallel to the x-axis.

The supply of land for the industry (all farmers growing the same crop) is not perfectly elastic. It rises upward from left to right, which means that by offering higher rent, land can be withdrawn from other uses, and thus the supply of land can be increased.

Q.6) Differentiate between Differential Rent and Scarcity Rent. 

Differential rent is the rent that arises due to the difference in the productive capacity of lands.
Rent on any piece of land will be equal to the difference between the cost of producing the output on that land and the cost of producing it on marginal land. The more superior land will have higher differential rent. Suppose, there are three grades of land A, B, and C, situated in the same location. A is more fertile than B and C which is the marginal land. Both ‘A’ and ‘B’ will command differential rent over ‘C’. The rent of ‘A’ will be greater than that of ‘B’
Scarcity rent is the rent that arises because of the scarcity of lands in relation to the demand for lands. Scarcity rent is different from differential rent explained by Ricardo. Differential rent arises because of the difference in the productivity of lands. But scarcity rent can arise even if all lands have the same quality.
Suppose, all land is of A quality. So long as the total demand for the products can be met by cultivating only a part of the total quantity of land available, there will be no rent. If the demand for produce rises and by applying one unit of labor on every acre, enough production is not available, second units of labor will be used. If due to the law of diminishing returns, the second unit just meets the cost of cultivation, the first unit will produce a surplus, which is rent. This is scarcity rent because it is arising because the supply of land is inelastic, and we must use more doses on the same land.

Q.7) Write a note on Quasi Rent.

Quasi rent is that temporary rent that arises due to fixed supply of any factor other than land. The concept of quasi rent was introduced by Marshall. Certain factors such as machines, ships, houses, and even human ability may be fixed in supply in the short run. When demand rises, they earn extra amounts which are called quasi rent. It is not rent but is like rent. As the supply of the factors can be increased in the long run, the temporary surplus or extra income i.e. quasi rent will be eliminated.
Suppose, in a locality two doctors A and B are practicing and doctor ‘A’ is earning Rs.40,000 a month. By chance doctor ‘B’ gets employment in Saudi Arabia. He leaves. Now, only doctor ‘A’ is available in the locality. His earnings rise, say to Rs.60,000 a month. So, he earns an additional income of Rs.20,000. This is quasi rent which doctor ‘A ‘earns because the supply of doctors in that locality is not increasing in the short run. This surplus income of Rs.20,000 may be eliminated in the long run, when some new doctor is attracted to the locality. Similarly, suppose, on someday, wagons and minibuses go on strike. Due to the temporary shortage of Taxi/rakshas, their owners earn additional income, which is quasi rent which may disappear the next day.

number of machines
Economics Notes Chapters 11 to Chapter 17 40

Q.8) Write a note on rent and Unearned Income. 

Rent As Unearned Income
One view about rent is that it is unearned income. The reason given is that land is a gift of nature. No cost is involved to supply it. In this respect, land differs from labor and capital. Labor must be reared, educated, and trained. Capital must be created by using labor and other scarce resources. But nothing is needed to be done for land. From it follows that any increase in the value of land and other natural resources due to rising populations and additional demand accrues to the owners of these resources as a windfall gain – it does not arise from any efforts on their part. Natural resources will be available even in the absence of payment of rent. “Why then, any payment is made to those who by historical accident, by inheritance, allotment by corrupt governments, and by hook or crook happen to be landowners. It is argued that land should be nationalized (owned by the state) so that the payment for its use can be utilized by the state for the well-being of the whole population rather than by a land-owning minority. so are the rents. Thus, landlords are receiving very high incomes without doing any productive work. Many economists and social reformers have the opinion that land rent should go to the nation. So it is suggested that all rental income should be taxed away by the government and spent on public uses.
Critics of the above view say that firstly the incomes of landlords combine elements of interest. rent. wages and profits. Rent cannot be easily separated. Secondly, the question of unearned incomes goes beyond rent. When prices rise, many people gain on capital and other goods without effort. We may conclude, however, that most of the rent is unearned income and the government must impose a tax on landowners to get at least a part of its rent (unearned income).

Exercise (Interest)

Q.1) Define the terms.

Interest, Gross interest, Net / Pure interest, Liquidity Preference, Demand for money, Speculative motive, Transaction motive, Supply of money.

Interest, in finance and economics, is a payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum (that is, the amount borrowed), at a rate.
Gross interest: 
Gross interest is the annual rate of interest to be paid on an investment, security, or deposit account before taxes or other charges are deducted.
Net / pure interest: 
Pure or Net interest. It is the payment for the use of capital or money only.
Liquidity preference: 
(in Keynesian theory) the preference of investors for holding liquid assets rather than securities or long-term interest-bearing investments.
Demand for money: 
The demands money is the desired holding of financial assets in the form of money: that is, cash or bank deposits rather than investments.
Speculative motive: 
A desire to hold cash in order to be poised to exploit any attractive investment opportunity requiring a cash expenditure that might arise.
Transaction motive: 
The desire of an economic actor to maintain enough funds in a bank account in order to write checks on that account for daily needs and wants.
Supply of money:
The money supply is the entire stock of currency and other liquid instruments circulating in a country’s economy as of a time. The money supply can include cash, coins  and balances held in checking and savings accounts, and other near money substitutes.

Q.2) Differentiate between Net and Gross Interest. 

The total amount which a borrower country to the lender for use of money is called gross interest. The whole amount is not the price for use of borrowed money. It may include the following payments.
i) Pure Interest This is the payment for only the use of borrowed funds.
ii) Insurance against Risk When a person lends money, he bears the risk. It is possible that the borrower may refuse to return the money or due to loss in the business, he may be unable to repay the loan. Thus, when a lender fears that he may not get back his money or interest, he will charge a higher rate of interest. This extra payment is insurance against risk.
iii) Wages of Management. The lender must keep accounts. Sometimes, I employs persons for this job. In this way, he must spend an amount which he recovers from the borrower. Therefore, the rate of interest charged by him will be higher. Banks employ clerks, accountants, managers, etc. Their salaries are paid out of interest on banks’ loans.
iv) Returns for Inconvenience When a person lends money, he cannot use it himself for a period. I have bears inconvenience. Thus, the gross rate of interest charged by him also includes some extra payment for this inconvenience.

Net interest is the price for use of capital (capital may be in money form or in some physical form e.g. machine.) Capital is not a free good. Its supply is always less than demand. So, the owner of the capital must get some return for its use.
When a lender has no fear or doubt about the recovery of loan, the interest rate charged by him is net or pure interest. “Net interest does not include charges for keeping accounts. When a person uses his own capital in his business, his income from the business includes net interest. In such a case, interest is equal to the amount, which he could receive by lending that capital.

Q.3) Why Interest is paid?

WHY INTEREST IS PAID is payment of interest necessary? Controversy has long existed over this issue. Many religions have preached against interest. They have reasons for taking this stand. The main consideration behind anti-interest religious views is that interest is a form of exploitation of borrowers and strengthening the position of capital against labor in economic activities. So interest is considered a crime against humanity as a whole. Socialist writers like Karl Marx have also condemned interest. However, interest is continuing in almost all economies of the world. This situation exists due to many reasons.

Q.4) Discuss and evaluate the liquidity preference theory of interest. Explain Keynes’ theory of interest. 

This theory was given by Lord Keynes. ” He thinks that interest is the reward for sacrificing liquidity of money or “rate of interest is determined by the demand for money (liquidity preference) and supply of money”. He says that people give preference to hold a part of their incomes and wealth in liquid form i.e. cash or check-able deposits and part with liquidity (lend) only when they are offered interest. Demand for money or ‘Liquidity Preference ‘arises for three reasons.
i) Transactions Motive. (or transaction demand for money) People need cash for day-to-day transactions i.e. to buy goods and services. The transaction motive has two parts; income motive ‘and business motive. Under income motive, people hold cash to bridge the interval between receipts of income and their expenditure. Under business motives, the businessmen hold some cash to meet their running expenses of production.
A person earning Rs. 60,000 per month must spread the expenditure over the whole month. He must have some cash until the next salary or wages. The amount held under income motive depends on the size of income and on the length of the interval after which income is received. There are two persons A and B each earning Rs. 60,000 a month. A gets Rs. 15000 weekly while B received Rs.60,000 monthly. Person B will keep more cash with him since he must arrange expenditure for a month and not a week like A. Business people hold cash to meet expenses of wages, raw materials, etc. The size of firm’s output determines the required cash.
ii) Precautionary Motive People hold money to meet emergencies and unforeseen expenditure e.g. illness, accidents, unemployment, business changes. The amount kept depends upon the level of income, business activities, political conditions, and personal habits. “Money held under precautionary motive is like water kept in reserve in a tank.” Precautionary demand is relatively small.
iii) Speculative Motive (or speculative demand for money) People keep assets in liquid form to get the advantage of the changes in prices of bonds, securities, etc. in the stock market. The speculative demand for money depends upon the rate of interest. At a higher rate of interest, less amount of money will be kept.
Total Demand for Money = Transaction Demand + Speculative Demand
Demand for money is inversely related to the rate of interest. So the demand curve (liquidity preference) falls downward.

Q.5) Explain Keynes theory of Interest?  

Keynes theory of Interest
According to Lord Keynes, interest is the reward for parting with liquidity. People prefer to hold their wealth in the form of cash or liquid funds for the three reason. 
a) Transaction Motive i.e. for purchasing goods and services. 
b) Precautionary Motive i.e. to meet emergencies. 
c) Speculative Motive i.e. to take advantage of changes in rate of interest. 
They agree to part with funds only when they expect some reward i.e. interest. 
This theory deals with the question of interest only in money terms and ignores real forces like demand and supply of Capital goods.  

Q.6) Explain the loanable fund’s theory of Interest.

According to this theory, interest is the price paid for the use of loanable funds. Supply of Loanable Funds
1. Household savings are the chief source of funds for lending.
2. Business saving Firms retain some earnings for investment and meeting depreciation needs.
3. Bank Credit is a big source of supply of loanable funds. Banks create deposit money
4. Government and Central Bank supply funds – government through the budget and central bank by increasing the money supply.
5. Foreign Saving is also a source of supply of funds.
The supply curve of loanable funds is upward sloping i.e. more supply at higher interest rate.
Demand for Loanable Funds
Four sectors of the economy-household, business, government and foreign create demand for loanable funds.
1. Households may need borrowing e.g. for construction of houses. People borrow more money at lower interest rates.
2. The business sector wants loanable funds to purchase investment goods, plants, equipment, materials, etc.
3. The Government can also borrow when its budget is a deficit. This demand is vertical because the government’s demand is not dependent on the level of rate of interest.
4. Foreign governments and corporations may also borrow funds.
Aggregate demand for loanable funds is obtained by adding the individual demands of various sectors. This demand makes a downward sloping curve indicating that more funds are demanded at lower rates of interest.

Q.7) Write a note on Zero Rates of Interest

The concept of interest; its meaning, nature, and justification has been discussed for centuries. The economists discuss the concept purely from an economic point of view while religious and social leaders deny its justification on moral and religious grounds.
The economists argue that interest is the reward for the services of an important factor of production i.e. capital. Since capital is scarce and possesses productivity, positive reward or price must be paid to the owner of capital. However, they sometimes discuss the theoretical possibility if the rate of interest would ever fall to zero. In this regard, two considerations are given weight.
i) As time passes and people’s incomes rise, their capacity to save will increase so much that they would save even if no interest is expected. The situation may turn to such an extent that the savers may offer a fee for keeping their savings safely.
ii) With new technology, the production of goods will rise fast, and huge accumulation of capital will take place, so much so that the supply of capital may outstrip demand for it.
If we Consider These points, we find That can rarely Such a situation ARISE. Firstly, with the passage of time, the population increases. More goods are needed, which means demand for more capital. Secondly, as the people’s standard of living rises, the variety in their wants becomes important. More capital will be needed to produce new varieties of goods. Thirdly, the progress of technology and scientific discoveries introduces new kinds of goods and the production process becomes more capital-intensive. When there was no steam engine, nobody thought of it. Then came the engine and electricity and opened new fields for investment. Similar has been the case with T.V. computers and mobile phones etc. Thus, no chance appears that the marginal productivity of capital will ever become zero. Fourthly, since people always prefer present consumption to future consumption, they will not lend a part of income unless they expect compensation in the form of interest.
Considering the above discussion, we may conclude that from an economic point of view, there is no possibility that the rate of interest will ever fall to zero. “The supply of capital may increase to any extent, but capital will remain scarce. It will always command a price for its use.

Q.8) What is the difference between Interest and Profit? 

The main difference between interest and profit is that interest is given for the use of capital whereas profit is a reward for entrepreneurship. Interest is determined by the demand and supply of capital. Profitability is determined by the efficient allocation of factors of production.

Exercise (Profit)

Q.1) Define the terms. 
Profit, Gross Profit, Net or pure profit, Windfall profits, innovation, Entrepreneur. 

Profit: Profit describes the financial benefit realized when revenue generated from a business activity exceeds the expenses, costs, and taxes.
Gross profit: Gross profit is the profit a company makes after deducting the costs associated with making and selling its products, or the costs associated with providing its services.
Net or Pure profit: The pure profit earned by a company in a particular accounting year is known as Net Profit.
Windfall profits: A windfall gain or windfall profit is any type of unusually high or abundant income that is sudden and / or unexpected.
Innovation: Innovation in its modern meaning is “a new idea, creative thoughts, new imaginations in the form of device or method”.
Entrepreneur: A person who sets up a business or businesses, taking on financial risks in the hope of profit.

Q.2 a) Explain why profits are paid? 
b) Differentiate between Gross and Net profits? 
c) Account for inequality in profits? 

Explain why profits are paid:
Profit is the revenue remaining after all costs are paid. These costs include labor, materials, interest on the debt, and taxes. Profit is usually used when describing the business activity. But everyone with an income has profit. It’s what’s leftover after paying the bills.
Profit is the reward to business owners for investing. In small companies, it’s paid directly as income. Incorporations, it’s often paid in the form of dividends to shareholders.
Differentiate between Gross and Net Profits. 
The difference between gross profit and net profit is when you subtract expenses. Gross profit is your business’s revenue minus the cost of goods sold.
Net profit is your business’s revenue after subtracting all operating, interest, and tax expenses, in addition to deducting your COGS.
Account for inequality in profits.
Income includes the revenue streams from wages, salaries, interest on a savings account, dividends from shares of stock, rent, and profits from selling something for more than you paid for it. Unlike wealth statistics, income figures do not include the value of homes, stock, or other possessions. Income inequality refers to the extent to which income is distributed in an uneven manner among a population.

Q.3) What is difference between intrest and profit? Distinguish between the services performed by the receiver of intrest and the receiver of profit. 

Profit versus interest:
Interest is the payment for the use of borrowed funds. It has two characteristics. i.e. it is a predetermined fixed rate of return and in money terms, it is always positive. Profit is the reward of an entrepreneur for organizing the business and facing uncertainty. It differs from interest on the point that it is neither fixed nor always positive. It is variable and may be negative (loss).

Q.4) Describe the best theory of determination of profits. Support with arguments. 

Monopoly Theory of Profits:
This theory explains that normal benefits are attributed to the monopoly power enjoyed by firms. Monopolistic enterprises restrict their production and charge higher prices than under perfect competition. This means that monopolistic companies are getting above-normal profits.
Joan Robinson, E.H. Chamberlin, M. Kalecki associates supernatural profits with the monopoly enjoyed by some companies. Because of the significant barriers to entry, monopolistic businesses can continue to make economic gains, even in the long run. Monopoly may arise from the exclusive control of certain raw materials that are essential to the manufacture of a product, economies of scale, legal sanctions or patents, government restrictions on the importation of a product.
Business man know that monopoly position can arise their profit. So, they always try to create more and more monopoly element in the market for their product. They try to eliminate their rivals by various tactics.

Q.5) Take an example of a bus owner on the lines similar to the example of a tea shop given this chapter and find out his net and gross profit.

Gross profit = 15000
Interest of his own capital = 500
Rent of his own shop = 1500
Wages of his labour = 5000
Total = 7000
Net profit     Gross profit – total = 15000 – 7000 = 8000

Q.6) Describe knight’s theory of profits. 

Prof. Knight explained the relationship between profit and risk. He says that insurable risks such as fires and accidents do not generate profit. These risks can be estimated with good accuracy with the help of statistics and insurance companies are ready to insure them against a small amount (premium). Uninsurable risks that relate to uncertainty about future changes in market conditions are the cause of profits. In some economic activities risk is inherent e.g. Oil exploration Some projects are like gambling – success or failure. The outcome of such investments is unpredictable and is not insurable. Profit is the reward for such uncertainty-bearing.

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