Economics : 2006 : CBSE : [ Delhi ] : Set I

A situation under which the consumer gets the maximum level of satisfaction from his given income and market prices of the commodities, then it is called consumer equilibrium.
In case of single commodity the condition of consumer equilibrium the marginal utility in terms of money is equal to the price. Thus

              Price    =     Marginal Utility of a product
                                    Marginal utility of a rupee                                    

The expenditure method of measuring price elasticity of demand is based on total expenditure on the commodity. According to total expenditure method, price elasticity of demand is measured as under:
(i)When a fall or rise in price does not cause the change in total expenditure on the commodity, elasticity of demand is unity(ED=1)
(ii)When a fall in price leads to increase in total expenditure or rise in price reduces total expenditure elasticity of demand is more than unity (ED>1)
(iii) When a fall in price reduces total expenditure or rise in price increases total expenditure, elasticity or demand is less than unity. (ED<1)

Expenditure Method may be explained with the following example:

	Price	Quantity	Total Expenditure	Elasticity
Case I Case II Case III	6 5 5	50 80 60	300 400 300	More than one Unity Less than one

The demand is said to be inelastic when a full in price reduces total expenditure or rise in price increases total expenditure.

When more and more units of a variable factor are applied with fixed factors to increase the production. It is said to be laws of returns to factor. In such a situation total product, marginal product and average product passes through three stages.
          The law of diminishing returns arises because the factors of production are imperfect substitutes for one another. For example, more and more labour cannot be used in place of capital. As more and more units of the variable factor is combined with the fixed factor and it gets over utilized the diminishing returns takes place in the economy. Law of Diminishing returns is the ultimate stage of production function. It applies in the short run due to internal diseconomies.

The reasons for rightward shift of supply curve are: 

(i) Fall in the cost of factors of production: When the cost of factors of production goes down, the producer will be able to produce more because the lower cost of production will supply more factor inputs. Therefore the supply curve will shift to the right.

(ii) Uses of improved technology: Due to uses of new technology the unit cost of production will decrease and supply will increase. As a result, supply curve will shift to the right.

(iii) Fall in the prices of other commodities: If the prices of all other commodities fall they will become relatively less attractive to the producer and the supply of the commodity, the price of which has not changed, will become more. Hence its supply will increase and there will be a rightward shift of supply curve.

Multiplier (k)= ∆Y/∆ I
The value of multiplier depends on the marginal propensity to consume. It is directly related to the marginal propensity to consume.

The relation is as under:

k = 1 / 1-MPC

The minimum value of multiplier will be one if the value of MPC is equal to zero. It is shown as:

k = 1 / 1-MPC

= 1

Investment multiplier is defined as the change in national income due to change in investment. It is the ratio of change in income to change in investment.

Aggregate demand refers to the total demand for goods and services in an economy in a particular year. Private consumption demand, private investment demand, government demand or purchases and net exports are four components of aggregate demand. But for the sake of simplicity, modern economists denoted aggregate demand in terms of consumption demand and investment demand. Symbolically,
          AD=C+I 

The major components of aggregate demand are:                                   

• Household consumption expenditure: It is the most important component. It refers to the total expenditure incurred by the household on the purchase of goods and services to satisfy their wants.
• Investment expenditure: It refers to the expenditure incurred on private firms and government on the purchase of capital goods such as plant, equipment, construction works etc. 
• Government consumption expenditure: It is the third component of aggregate demand. It refers to expenditure incurred by the government on the purchase of goods and services.
• Net exports: It reflects the demand of foreign countries for our goods and services over our demand for goods and services from foreign countries .

The basis of classifying the government expenditure into revenue and capital expenditure is whether expenditure creates assets or reduction in liabilities of the government.
Revenue Expenditure: All those expenditures which do not create any physical or financial assets are known as revenue expenditure.
Following are the examples of revenue expenditure:

•          Expenditure on defence
•          Expenditure on law and order
•          Expenditure on health
•          Expenditure on salaries, pensions etc

Capital Expenditure: All those expenditure of the government which lead to the creation of physical or financial assets are known as capital expenditure.

Following are the examples of Capital expenditure:

•               Expenditure on residential buildings
•               Expenditure on scientific research organisations
•               Expenditure on roads and bridges.

Gross value added at factor cost = Sales + Change in stock + Subsidies – Purchase of raw materials
= 180 + 15 +10 - 100
= Rs 105 Lakhs.

i Recovery of loans: It is treated as capital receipt because it causes reduction of assets.

ii Corporation tax: It is treated as revenue receipt because it neither creates liability nor leads to reduction in assets. It is an item of recurring nature.

iii Dividends on investment made by the government: It is treated as revenue receipt because it neither creates liability nor leads to reduction in assets. It is an item of recurring nature. 

iv. Sale of public sector undertaking: It is treated as capital receipt because it causes reduction of assets.

Foreign exchange rate: It is the rate at which currency of one country can be exchanged for currency of another country. Exchange rate is the price of one currency expressed in terms of another currency. For e.g.: if Rs 46 is to be paid to buy one US Dollar, then exchange rate between the two currencies will be, $1=46.

Relation between foreign exchange rate and supply of foreign exchange:

There is a direct relation between foreign exchange rate and supply of foreign exchange.

A rise in foreign exchange rate causes a rise in the supply. The shape of supply curve for foreign exchange is upward sloping. This means that the supply of foreign exchange varies directly with price of foreign exchange.